The Effects of External Debt on the Economic Growth of India during Various Crisis Periods: A Markov- Switching GARCH Model Approach

Abstract

This article seeks to investigate the impact of the volatility of the external debt burden on the economic growth of India. The MS (Markov - Switching) - GARCH model is the cornerstone in studying the effects of external debt on the economic growth that is simulated herein. This article applies a MS - GARCH model that allows not only unobserved variables within an observed model but also uses a robust algorithm to reach strong optimization (convergence) through iteration in a dynamic system in the estimation procedure. This article considers the period from Q2 2004 to Q4 2022 with 74 sample observations. Considering various crises like the global financial crisis, the Euro crisis, and the COVID-19 pandemic that occurred during the study period, the results identify two regimes based on conditional volatility. One is the global financial recession period (regime-1) and another is the post-global financial recession period (regime-2). The findings show that the conditional volatility as well as the variance in the volatility of economic growth due to the external debt of India is much stronger in the global financial recession period (regime-1) than in the post-global financial recession period (regime-2). It implies that the Euro crisis and the COVID-19 pandemic are having less impact on external debts in India. The transition matrix indicates the greater probability of the economic growth rate settling down in regime 2 when it is already in regime 2, as it is considered to be a much calmer period. Finally, the results of the stable probabilities suggest that the economic growth rate of India is much more stable in regime 2 than in regime 1. This article puts forward relevant policy implications for coming out from the debt overhang scenario in India.