Growth, External Debt, and Sovereign Risk in a Small Open Economy

Fiscal Policy and Management in East Asia, 2007

High ratios of external debt to GDP in selected Asian countries have contributed to the initiation, propagation, and severity of the financial and economic crises in recent years, reflecting runaway fiscal deficits and excessive foreign borrowing by the private sector. More importantly, the servicing of large debt stocks has diverted scarce resources from investment and long-term growth. Applying and calibrating the formal framework proposed by Villanueva (2003) to Philippine data, we explore the joint dynamics of external debt, capital accumulation, and growth. The relative simplicity of the model makes it convenient to analyze the links between domestic adjustment policies, foreign borrowing, and growth. We estimate the optimal domestic saving rate that is consistent with maximum real consumption per unit of effective labor in the long run. As a by-product, we estimate the steady-state ratio of net external debt to GDP that is associated with this optimal outcome. The framework is an extension of the standard neoclassical growth model that incorporates endogenous technical change and global capital markets. The major policy implications are that in the long run, fiscal adjustment and the promotion of private saving are critical; reliance on foreign saving in a globalized financial world has limits; and when risk spreads are highly and positively correlated with rising external debt levels, unabated foreign borrowing depresses long run welfare.

2009

Pressacademia, 2015

This study aims to contribute to the understanding of the impact of external debt on economic growth by using the data for moderately indebted middle-income countries over the period of 1985-2013. The paper employs a relatively recent panel analysis technique, the common correlated effects (CCE) framework, which considers cross-sectional dependence and heterogeneity implications in the data. Our overall findings suggest a negative linear effect of external debt for the panel despite some exceptions in the country-specific results. In the panel results, the impact of external indebtedness occurs through the debt stock rather than a direct impact of liquidity constraint represented by a debt service variable. 1.INTRODUCTION During the 1950s and 1960s foreign resources were considered as significant for development and economic growth of less developed economies (e.g. Avromovic et al., 1964; Chenery and Strout, 1966) 1. It was argued that countries at early stages of development did not have sufficient resources that could be devoted to investment, which in turn, was crucial for economic development. External debt was seen as an important source of economic growth for developing economies through its impact on capital accumulation, human resource development and infrastructure improvement. As foreign aid and/or foreign debt were seen almost inevitable, many developing countries exerted external resources at an increasing rate. Most of these countries borrowed to compensate insufficiency of domestic savings and to meet foreign currency need for imports of intermediate and capital goods. As a result, their indebtedness intensified and reached critical levels, eventually resulting in foreign debt crises in a number of economies at the end of the 1970s or in the early 1980s. In the meanwhile, the share of private loans compared to official financing in total foreign indebtedness started 1 Although the Harrod-Domar model was not developed to offer solutions to the issues in the less developed economies, it was used by the economists who debated for the significance of external resources for those.

2002

Understanding the investment role of foreign borrowing is a crucial issue for developing countries. Along this line of inquiry, the present paper analyzes the borrowing behavior of a developing economy that relies on imports for its capital formation. First, the case where the borrowing interest rate goes up with an increase in debt is examined. The model's implications concern the significance of the levels of productivity and the initial domestic capital for the economy not being on the poverty trap but on a growth path. Second, the case where the borrowing interest rate goes up with an increase in debt/total-capital ratio is examined. The results are radically different from the first case. The economy converges to stable equilibrium, irrespective of the initial capital level.

2024

Journal of Business Economics and Management, 2012

This paper proposes a study on the contribution of external debt to the expansion of economic growth for 31 developing countries. Over a period of 36 years, by using dynamic panel data econometrics estimation GMM-system, the results reveal that the accumulation of external debt is associated with a slowdown in the economies of the developing countries. In addition, this paper finds evidence that debt service ratio does not crowd out the investment rate in developing countries. In other words, even though external debt is negatively associated with economic growth, countries are found to be safe from being in the debt overhang hypothesis. Furthermore, there is evidence to support the existence of spatial dependence in the growth model, suggesting the existence of a positive spillover effect of growth among the neighbouring countries.

2013

This paper explores long run relationship between external debt and economic growth in developing economies. By using a sample of 70 developing countries over a period of 1976-2011, the study finds that increase in external debt stock reduces the fiscal space to service external debt liabilities and thus dampens the economic growth. Moreover, it reduces the level of private fixed capital formation in the country. Exploring the role of investment towards economic growth, we find that both the foreign direct investment and the fixed capital formation help these economies to grow, while openness contributes to the welfare of the developing economies. JEL Classification: F34; F43; O47