Investigating the debt-growth relationship for developing countries; a multi-country econometric analysis

Debt which emerged as a result of excessive lending by the advanced nations to disorganised and badly managed economies is oppressing the world’s poorest and most vulnerable whilst enriching wealthy creditors. This study investigates the relationship between debt and the economic growth of 56 heavily indebted poor countries from 1969 to 2000 in three empirical chapters. The first empirical chapter examines the non-linearity of the debt-growth relationship, i.e. it estimates the threshold below which debt enhances growth whilst above which debt prevents growth. The preferred endogenous threshold model of Hansen (1996, 2000) suggests that debt becomes detrimental to growth when debt-to- GDP ratio approaches 45%. Hence a country’s debt is considered sustainable, in the sense that it affects growth positively and can be serviced without any difficulty, as long as its debt-to-GDP ratio is below 45% threshold. An alternative to threshold concept of debt sustainability is the concept of intertemporal sustainability, which defines debt as sustainable providing that actual debt level equals the present discounted value of future trade balance surpluses. This, in terms of the time series properties, implies that debt is sustainable if there is long-run economic relationship between debt stock and output. The second empirical chapter investigates this using numerous integration and cointegration methods. The results from the best tests suggest that debt is unsustainable. Nonetheless, these methodologies have low power and categorise countries into a simple dichotomy of sustainable vs. unsustainable, whereas in reality sustainability is a continuum measure. Thus, the final empirical chapter proposes the use of persistence techniques for assessing debt sustainability, i.e. estimating a Debt Sustainability Index (DSI). Estimates of the DSI conclude that Latin American and Caribbean (LAC) countries have less sustainable debt than Sub Saharan African (SSA) countries. Furthermore, the oil price, the interest rate and the commodity price shocks have played a substantial role in causing the debt crisis but the contribution of other factors unidentified is larger. The oil shocks are the most important for both groups whilst the interest rate is the least important for LAC and the commodity price for SSA.