The Causal Relationship between External Debts and Economic Growth in East African Community

Abstract

Abstract The interest in the causal relationship between external debt and economic growth has increased in the world due to its importance in whether a country is experiencing debt overhang or not. This study attempts to examine the causal relationship between external debt and economic growth in EAC’s founding partner states. The study employs Xtabond2 using a secondary panel data set for the period 1988 to 2020. The study conducted all required econometric tests such as panel data unit root set and overidentification test using Arellano Bond test, Sargan test and Hansen test respectively before proceeding with further regression. The findings reveal the negative impact of external debt on economic growth running from external debt to economic growth with no feedback indicating the debt overhang in these countries. Other moderating variables have shown different impacts on economic growth where the negative impact is revealed from inflation while positive impacts are revealed from gross capital formation, lagged dependent variable, and the square of total external debt. Other variables such as population size have no significant impact which might have been caused by the presence of a square of total external debt while the exchange rate has a short-run impact on economic growth. Therefore it is suggested that the policymaker should ensure that the loan secured is located on the project with a positive net profit to avoid further demand for external assistance on loan repayment. Also, all tax potentials available in these countries should be optimally exhausted to avoid reliance on external financing assistance. Moreover, these countries should ensure that all external debt secured is sustainable and solvency in relation to their economy.