Dynamics of foreign earnings, assistance and debt servicing in Bangladesh

Purpose – The purpose of this paper is to examine the dynamics between real gross domestic product (GDP), foreign earnings, development assistance and debt servicing in Bangladesh, 1973‐2008, with the incorporation of a structural break after 1990. Design/methodology/approach – A vector autoregression (VAR) framework using annual data from 1973‐2008 was used to examine the dynamics among the above mentioned variables, with the incorporation of a structural break after 1990. This was followed by innovation accounting and testing for Granger causality. Findings – It was found that the structural break is significant and all the macro‐variables exhibit trend stationarity. Innovation accounting suggests that the debt servicing capacity of Bangladesh is enhanced by an improvement in foreign earnings, an outcome which is reinforced by Granger causality tests. Research limitations/implications – A bigger sample size, consisting of quarterly observations is desirable. Practical implications – These results suggest that an increase in foreign earnings implies an improvement in the capacity to service overseas debt. Thus, from a policy perspective, it is recommended that steps be taken to diversify the sources of foreign earnings. The analysis affirms that there is a causal link between injections, represented by foreign earnings and overseas development assistance and leakages, represented by debt servicing. Such affirmation is certain to be an important input in macroeconomic policy formulation. Originality/value – The dynamics between real GDP, foreign earnings, development assistance and debt servicing in Bangladesh have been empirically examined using recent developments in time‐series econometrics.