Abstract
This study is an effort to determine the effect of public external debt on economic growth in Ethiopia. Specifically, the study tries to answer the questions whether stock of public external debt and public external debt servicing have any significance effect on economic growth of the country and it also determined the magnitude of the effect. In doing this, the study used an Auto Regressive Distributive Lag model (ARDL modeling) to analyze Ethiopian data from 1970 up to 2017 with real GDP as a function of stock of public external debt, public external debt servicing, human capital, physical capital, trade openness, labor force and policy change dummy. The empirical result reveals that in the long-run high level of stock of public external debt has a significant negative effect on economic growth and it poses great challenges on the economy. Hence, there is an evidence for the “Debt overhang” and “Conventional view” of public debt in Ethiopia. On the other hand, public external debt servicing has a negative coefficient but insignificant in affecting economic growth and there is no evidence for the “Crowding out” effect in the country. In the long-run result, human capital is also found to have negative impact on real GDP. Moreover, physical capital has a significant positive impact but labor force and trade openness is insignificant in explaining the Ethiopian economy. Hence, this study recommended the government of Ethiopia and local policy makers to improve the existing policies on public external debt management such as to invest in productive activities and sectors, to implement structural change, public sector reform and tax reform, should try to minimize the dependence on external borrowing through diversifying the economy so as to generate more revenue in the domestic.
Highlights
External debt is an important source of finance mainly used to supplement the domestic sources of funds for supporting development and other needs of a country
The overall objective of this study is to examine the causal linkage between external debt and economic growth in Ethiopia
It is vital and must to test the nature of stationarity of the variables before running Autoregressive distributed lag (ARDL) model, a model used to determine the existence of long run relationship among the variables
Summary
External debt is an important source of finance mainly used to supplement the domestic sources of funds for supporting development and other needs of a country. Countries with less developed domestic debt markets often rely on external borrowing to meet their financing needs. This is because the domestic debt market is shallow and cannot match the government financing requirements. As a result, their debt portfolio is mainly composed of external debt. Mukui (2013) observes that high levels of external debt in Ethiopia poses a great challenge to the economy given that a large proportion of the export income goes to servicing debts instead of being put into domestic investment Chawdhury (2001) admits that external debt may have huge effects on the overall performance of these countries. Mukui (2013) observes that high levels of external debt in Ethiopia poses a great challenge to the economy given that a large proportion of the export income goes to servicing debts instead of being put into domestic investment
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