Causes of External Debt Crisis in Developing Countries: An Analysis using Panel VECM

Abstract

This paper investigates the dynamic causal relationships between Debt Service, Current Account Balance, Total Reserves and External Debt of 72 developing countries for the period 1979 to 2014. The paper employed a panel unit root, panel cointegration, fully modified OLS and panel-based error correction model. The panel cointegration test revealed that there is a longrun relationship between external debt, debt service, current account balance, total reserves. The FMOLS results exhibited that there was a positive and significant impact of total debt service and reserves on external debt. Further, there is a negative and statistically significant impact of the current account balance on external debt. Panel VECM results indicated that there was a long run causal relationship among the variables bidirectional short-run causality runs between external debt and current account balance, external debt and total reserves and unidirectional short run causality run from external debt and total reserves to total debt service and total debt service to the current account balance. To check the direction of causality between the variables Dumitrescu-Hurlin Panel Causality test was employed. The outcome of the analysis revealed a bidirectional causality between the external debt, debt servicing, current account balance, and total reserves.