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 nationsto disorganised and badly managed economies is oppressing the world’s poorest andmost vulnerable whilst enriching wealthy creditors.This study investigates the relationship between debt and the economic growthof 56 heavily indebted poor countries from 1969 to 2000 in three empirical chapters.The first empirical chapter examines the non-linearity of the debt-growthrelationship, i.e. it estimates the threshold below which debt enhances growth whilstabove which debt prevents growth. The preferred endogenous threshold model ofHansen (1996, 2000) suggests that debt becomes detrimental to growth when debt-to-GDP ratio approaches 45%. Hence a country’s debt is considered sustainable, inthe 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 ofintertemporal sustainability, which defines debt as sustainable providing that actualdebt 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-runeconomic relationship between debt stock and output.The second empirical chapter investigates this using numerous integration andcointegration methods. The results from the best tests suggest that debt isunsustainable. Nonetheless, these methodologies have low power and categorisecountries into a simple dichotomy of sustainable vs. unsustainable, whereas in realitysustainability is a continuum measure.Thus, the final empirical chapter proposes the use of persistence techniques forassessing debt sustainability, i.e. estimating a Debt Sustainability Index (DSI).Estimates of the DSI conclude that Latin American and Caribbean (LAC) countrieshave less sustainable debt than Sub Saharan African (SSA) countries. Furthermore,the oil price, the interest rate and the commodity price shocks have played asubstantial role in causing the debt crisis but the contribution of other factorsunidentified is larger. The oil shocks are the most important for both groups whilstthe interest rate is the least important for LAC and the commodity price for SSA.