External Debt and Growth: In search of Ceiling for South Asian Economies

Abstract

Over the past few years, external debt positions of South Asian economies have increased to alarming levels, indicating that those countries are more likely to be exposed to a debt crisis. The inflationary pressure, and weakening characteristics of regional currencies against the USD, make those countries more vulnerable when it comes to servicing debt. On the other hand, given the low domestic savings rate of these economies, they are increasingly compelled to invest significant resources in public infrastructure in order to maintain sustainable growth momentum. Contemporaneously, those countries were also invited to enrich by merging with the synergies of the rest of the world in the fields of maritime, trade, and financial initiatives. In such a situation, where the recent controversy on the debt-growth association is still inconclusive; preserving external debt exposures at an optimal level is incumbent. Hence, this study focuses on examining the relationship between external debt and economic growth, while determining an optimal external debt exposure to be maintained by South Asian countries. Consequently, the annual observations of these independent cross-sections during the period of 1981-2017 has been reviewed for the purpose of this study. Moreover, the quantitative research strategy used to measure the expected outcomes primarily consists of panel ARDL specifications and fixed effect threshold regressions. Additionally, the relative strengths of countries' indebtedness were measured by a newly compiled REDV index. On aggregate levels of data, the results suggest that there is a statistically significant negative association between external debt and economic growth. Also, it has been observed that a significant nonlinear relationship exists for lower-middle-income countries. Accordingly, the economic growth rate turns positive to negative when the external debt surpasses 80.19 percent of GDP. Evidence from the REDV index signifies that among all South Asian economies, Bhutan and Sri Lanka are the most vulnerable nations to an external debt crisis.