Impact of External Debt on Economic Growth of Pakistan: An Empirical Evidence

Abstract

Pakistan has yet to be able to raise enough money to finance its budget over the years. As a result, the issue of twin deficits surfaced, and the government is now forced to rely on domestic and foreign debt to fund its developmental initiatives. The benefits of public debt stem from the fact that, in economies with limited resources, debt financing, when done correctly, boosts growth and increases the ability to service and repay public debt. This study aims to examine the effect of external debt on Pakistan's economic growth using data from 1985 to 2019. To estimate the model, an Augmented Dickey-Fuller (ADF) test was used to determine the unit root of the data. The ADF test results indicate that the empirical model's variables become stationary at the level. Based on the ADF results, the data is subjected to Johansen's cointegration test to ascertain the long-run relationship between the variables. Similarly, an Error Correction Model (ECM) approach was used to examine the short-run relationship between the variables. An ARDL bound test was used to check long and short-run relationships between independent and dependent variables. The study's primary conclusion is that external debt detrimentally affects Pakistan's economic growth. Additionally, other control variables, such as life expectancy, exports, and foreign direct investment inflows, remained statistically significant in the positive direction. The model's control variable results indicate that strategies promoting exports, foreign direct investment, and increasing health expenditures can all contribute significantly to Pakistan's economic growth. Policymakers should execute appropriate policies to reduce external debt, enhance export volume, and attract more foreign investment, which would help the country thrive economically. The study further suggested that to improve economic growth, Pakistan should focus on investment projects, and there is a need to implement better policies for foreign debt utilization.