External debt and growth: role of stable macroeconomic policies.
| Autor | Dey, Sima Rani |
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Introduction
The prime objective of any economic policy of developing country such as Bangladesh is to attain sustainable economic growth with infrastructural development and poverty reduction. However, when the government fails to meet their growth needs, they oblige to welcome financial assistance from the external sector, mostly in the form of debt. Bangladesh had to rely on debt and is still relying on external debt to manage the saving-investment gap and fiscal deficit since its independence.
External borrowing is not a negative issue for a country until it can generate higher returns than the cost of borrowing, but it becomes vicious if it is not used properly and prudently. External borrowing would be enhancing capacity and output growth hence, making the debt productive and justifiable (Poirson et al. (2002) and Pattillo et al. (2004)). On the contrary, this debt can create fiscal imbalances and excessive foreign borrowing that may make the country more vulnerable to different shocks and crises. It reduces the effectiveness of fiscal policies and limits the ability of the monetary authority to raise interest rates for monetary policy purposes, due to its effect on the budget deficit and debt (Beetsma and Bovenberg, 2003).
Although probable effects of large public debts on output growth are a major challenge for policymakers and public opinion in general, the empirical research addressing the debt-growth nexus in the context of Bangladesh is considerably scanty. Our study begins to highlight this issue through its investigation of the dynamic association between growth and external debt.
Given the fact, Bangladesh is still having a low debt-gross domestic product (GDP) ratio (Figure 1) and even the lowest per capita external debt in the South Asian region. So, it would be quite interesting to look into the debt-GDP nexus and how MEP affects this nexus in the context of Bangladesh throughout 1980-2017.
The objective of this study is to explore the impact of external debt on growth and how the MEP index can soothe to some extent or nullify the negative effect of external debt. Unlike any other studies on Bangladesh, this paper is significantly different as it analyses the external debt-growth relationship in a macroeconomic context taking the interactive term of external debt and policy in the model. Moreover, external debt is disaggregated to sketch their respective effects on growth independently. Vector autoregression (VAR) impulse response function (IRF) has been used to illustrate the dynamic effects of external debt shocks on growth and the shocks of the macro variable on economic growth.
This paper is organized into eight sections: starting with the introduction, Section 2 contains a review of the available empirical literature. Section 3 contains a brief discussion of the trends in external debt and growth in Bangladesh over the study period. Model specification and data are discussed in Section 4 while Section 5 contains the econometric methodology. Section 6 analyses the empirical results of the study and Section 7 presents the IRF. Conclusions with policy recommendations are described in Section 8.
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Literature review
Overabundances of studies have examined the effect of public debt on economic growth, whereas most of them have focused on external debt issues of developing countries generally. The results of the empirical studies are mixed and inconclusive; differing not only upon the country or group of countries investigated but also upon the study period, the model specification and estimation techniques, the set of control variables including the debt indicator variable. While the general conclusion of external debt studies is that external debt has an insignificant or negative relationship with economic growth. Though the studies on relating to Bangladesh are scanty. For the reason of parsimony, we attempt to compile a brief summary of the recent contributions to the external debt perspective in Table 1.
The existence of a negative relationship between external debt and growth is revealed by a good number of the studies. Even focusing on Bangladesh, we can state that majority of them exert a negative impact of external debt on growth. On the contrary, Saifuddin (2016) found an indirect positive effect on growth analyzing public debt, which is combined with external and domestic debt. So, the debate on the effect of external debt on economic growth, however, remains unresolved because of discrepancies in the results of extant studies.
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Overview of an external debt scenario of Bangladesh
The inception of the debt demand is the inability to meet up the deficit financing of the budget. There is a clear indication in the "Public Money and Budget Management Act 2009" to keep the budget deficit to a sustainable level. Therefore, the Bangladesh government is continuously trying to keep the fiscal deficit within 5% of GDP over the years. The Government borrows both from domestic and external sources to meet the budget deficit caused by the social welfare expenditure, unexpected expenditure in emergencies, development planning expenditure and increased investment. The budget of recent years shows a trend of the steady decline of dependence on external assistance. However, the principal and interest repayment for received loans by Bangladesh are gradually increasing (Finance Division, M. of F, 2017) (Figure 2).
The sound management of public debt can be judged by looking at debt to GDP ratio and the per capita debt liability. Then the next criterion is the status of servicing of the debt and the history of debt servicing. Bangladesh experiences success in the debt management policy. According to debt sustainability analysis of The International Monetary Fund (IMF), Bangladesh's risks of external debt distress and overall debt distress continue to be assessed as low. Until now Bangladesh never defaulted to service the debt nor ask for a rescheduling of debt. The debt-GDP ratio is the lowest in the South Asian region, which is below 30% from 2004 like our neighboring countries India and Pakistan, whereas the external debt-GDP ratio of Sri Lanka is around 55 %.
Also, Table 2 provides the detail of the external debt composition of Bangladesh. As of end-FY16, total outstanding external debt is estimated to be US$26.306bn (11.88% of GDP). External debt consists of medium to long term loans from multilateral and bilateral creditors, short term debt and borrowings of the state-owned enterprises. Multilateral creditors account for a large share of the external debt, with the World Bank and the Asian Development Bank being the largest creditors while The Organization for Economic Cooperation and Development (OECD) countries are the largest bilateral creditors.
Bangladesh government is truly aware of institutional strengthening and capacity building to deal with this external debt issue. So, historically the fiscal policy should set in a way that it can keep the budget deficit low or below 5% of GDP.
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Model specification and data
To evaluate the impact of external debt on economic growth, our targeted main variables are GDP and external debt to GDP ratio (EDG). However, few more variables are included as well in the model, namely, budget deficit to GDP ratio (BDG), inflation, secondary enrollment ratio and trade openness along with the above mentioned two variables. The population is taken as a control variable to avoid the variable specification bias.
Here are the justifications for using the above-discussed variables in the growth equation. Firstly, the fiscal management of government is a key determinant of growth. Studies of Fischer (1993) and Easterly and Rebelo (1993) examined the role of fiscal policy in determining the growth of output. They found that large and consistent budget deficits are negatively correlated with growth. Thus, a relatively low BDG should have a positive effect on reflecting macroeconomic stability.
Prices play a vital role in an economy to allocate resources efficiently, but high and rapidly increasing prices can distort economic stability. Thus, a high level of inflation may be inimical to growth by adversely affecting the decision-making effort of agents [Barro (1996) and Khan and Ssnhadji (2001) for details]. So, we expect inflation (INF) to adversely affect growth.
In the present growth theory, human capital is another core variable in explaining growth. Our growth model has taken the secondary school enrollment ratio (SER) as a proxy of human capital. The positive impact of human capital on growth is expected because educated and skilled people tend to be more productive.
Trade openness (TO), measured by total trade as a ratio to GDP reflects what extent an economy is linked to the rest of the world. An economy with a more open trade can quickly adopt newly developed ideas and equipment and is particularly important for developing countries. Gallup et al. (1998) showed that open economies are generally in a better position to import new technologies and new ideas from the rest of the world as compared to closed economies. Therefore, and following Barro (1996), Easterly and Levine (1997) and Collier and Gunning (1999), thus we expect to have a positive effect of TO on growth.
Because of being a labor abundant economy, the population (P) is a major component of economic growth which has a positive impact on growth.
The functional form of the model to satisfy the prime objective of the study is as follows:
[GDP.sub.t]=f [EDGt], [BDG.sub.t], INFt, [TO.sub.t], [SER.sub.t],[P.sub.t] (1)
The endeavor of our study is to spot the external debt and growth association in Bangladesh within a broader macroeconomic set-up. According to Fischer (1993), economic growth positively responds to the influence of sound MEP and causation runs from good MEP towards economic growth. He argues that growth is negatively associated with high inflation, large budget deficits and...
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