This paper would discuss the effect of external debt on economic growth with four areas, the effect on private local investment, foreign direct investment, government expenditure and export growth. Three theoretical models are adopted, namely Debt Overhang Theory, Liquidity Constraint Hypothesis and Crowding-out Effect respectively. Two policy implications on debt relief and debt restructuring are analyzed. And finally, the paper will include the discussion on the necessary tradeoff with inflation and contractionary fiscal budgeting after debt servicing.
KEY Words: Heavily In-debt Poor Countries (HIPC), External Debt/Foreign Debt) Sustainability, Debt-GNI Ratio, Debt-Export ...view middle of the document...
3.1 Debt-Relief and lengthened debt repayment P.14
3.2 Debt Restructuring P.16
4. Financial Dilemma: Inflation or contractionary fiscal policy? P.16
5. Conclusion P.18
In principle, borrowing external source of fund is beneficial to long term development; however, the empirical data on Latin-American, African and some East Asian countries have shown a negative relationship with increasing debt and economic growth. To attain a sustainable economic growth for underdeveloped countries (UDC), it is important to reinvestigate whether external debt is negative to economic growth. In this thesis, I will focus on the empirical analysis on Argentina with two-sided effect of external debt on economic growth, and will provide empirical analysis of external debt on investment (local private and foreign direct investment), government expenditure and export growth. Also, based on debt overhang theory, I will give suggested solutions to overextension of external debt, including debt relief and deferred payment. And finally, I will demonstrate the necessary tradeoff between inflation and contractionary fiscal effect on economy.
The definition of (Gross) External Debt/Foreign Debt is one of the sources to finance capital formation for an economy (Adepoju et al, 2007). It is the outstanding amount of current liabilities to non-residential units. But the nature of external debt is that the borrowing is not asset-backed by collaterals, i.e. the creditor has no property right on the debtor country’s asset if the debtor country defaults. While it consists of public and private external debt, the following will focus on public only.
1.1 Literature Review
The past literatures are mainly consists of three different models: Debt Overhang Theory, Liquidity Constraint Hypothesis and Crowding-out Effect respectively.
The related journals on debt overhang are Koeda1 (2006),KARAGOL(n.d.), both scholars stressed that the debt overburden would reduce economic growth in long run.
The relevant article(s) on liquidity constraint hypothesis is Shabbir (n.d.), he proposed that the high foreign debt would induce contractionary fiscal budget.
Lastly, the article(s) on crowding-out effect is Adnan (2008), he reveals that the borrowed foreign debt for government spending would cost export shrink with currency appreciation.
1.2 Overview on External Debt Indicators of Argentina
Source: World Bank
The Debt to GNI ratio reveals the debt stock to existing economic output, which is the leverage ratio of economy. The maximum point appears on 2004 which represents the higher interest cost burden and high risk for financial distress.
Source: World Bank
The above debt export...