Public Debt and Economic Growth Incorporating Endogeneity & Non-linearity

Abstract

For developing countries, the rate of debt accumulation and increase in debt servicing are highlighted as major factors affecting the growth rate of output. The downward pressure was larger in the countries facing higher debt burden as these countries faced higher interest rates, decline in the external resource inflow, lower export earnings, lower domestic output and lower imports. In case of South Asian countries, the external debt scenario has changed over time. The rapid accumulation of debt, rising repayment burden and rescheduling of debt has raised concerns regarding the impact of debt on the growth process of the South Asian countries. It is well established in literature that the public debt and economic growth bear positive and non-linear relationship. However, in recent literature, evidence of no relationship is found when accounted for endogeneity in case of advanced economies (Rogoff & Reinhart, 2009 and Panizza, 2014). This finding provides the motivation to reexplore the relationship between public debt and economic growth under non-linearity and endogeneity in context of developing economies of South Asia including Pakistan, India, Bangladesh and Sri-Lanka for the period 1980-2014. There exists a significant positive but nonlinear relationship between the public debt and economic growth for the selected set of developing countries when accounted for endogeneity and non-linearity. The threshold level for SAARC region is 61% which is quite lower than developed countries which have threshold level near to 90%. This study also computes the threshold levels for sustainability of debt for individual countries and finds that Pakistan and Sri-Lanka need to control their public borrowings as their current debt levels are higher than the respective thresholds.