Empirical examination of debt and growth nexus in South Asian countries

Over the years, South Asian countries have been facing the problem of a twin deficit and the need to rely on public external and domestic debt to finance their developmental activities. The positive impact of public debt relates to the fact that in resource-starved economies debt financing, if done properly, leads to higher growth and adds to the borrower’s capacity to service and repay external and internal debt. The negative effect works through two main channels, namely “debt overhang” and “crowding out”. In the present study, the consequences of public debt for economic growth and investment are examined for the four countries in South Asia, namely Bangladesh, India, Pakistan and Sri Lanka, for the period 1975-2011. To conduct the study, a hybrid model that explicitly incorporates the role of public debt in growth equations was developed. The standard panel data estimation techniques have been used. The results show that both public external debt and debt servicing negatively affect economic growth and investment, which points to the existence of the “debt overhang effect” and the “crowding out effect”. Similarly, domestic debt also exhibits a negative and significant relationship with economic growth and investment. The results suggest that reliance on debt for development purposes is not a safe option and countries need to extend the efforts to increase the revenue to finance the development expenditure.