economics

The economics essay below has been submitted to us by a student in order to help you with your studies.

External Debt And Debt Servicing On Ecowas Countries Economics Essay

ABSTRACT

This thesis examines the effect of external debt and debt servicing on ECOWAS countries economic growth over the period (1960 to 2008). The debt –growth model used in the study includes external debt stock, debt servicing and the Gross Domestic product of each individual country, the data used was times series data. The results illustrate that the economic effect of external debt stock and its servicing varied for different countries among the ECOWAS. In addition, external debt contributes positively to growth in Benin and Niger while the impact of external debt stock and debt servicing was severe on the economic growth of Burkina Faso, Cote d’Ivoire, Gambia, Guinea- Bissau, Nigeria, Sierra-Leone and Togo.

Keywords: External Debt, Debt Servicing, Economic Growth and ECOWAS.

ÖZ

ACKNOWLEDGMENT

I would like to thank my supervisor, Associate Professor Mustafa Besim for his continuous support, motivation and guidance mainly for the interest attached in the preparation of this study. Without his invaluable supervision, all my efforts could have been limited.

I also want to thank Associate Professor Salih Katircioglu for continuous help he has been provided to support my effort.

Also I am grateful to all my lecturers and to my friends: Taiwo Daniels and others for their contribution.

Thanks to my family who allowed me to travel all the way from Nigeria to Cyprus and supported me all throughout my studies. I would like to dedicate this study to them as an indication of their significance in this study as well as in my life.

DEDICATION

To My parent Mr. and Mrs. Anifowose, Ronke Akinsulire (Fiancée), Iponti Kehinde and Abraham Alaba Bunmi.

TABLE OF CONTENTS

ABSTRACT ii

Keywords: External Debt, Debt Servicing, Economic Growth and ECOWAS. ii

ÖZ iii

ACKNOWLEDGMENT iv

DEDICATION iv

TABLE OF CONTENTS vi

LIST OF TABLES viii

INTRODUCTION 1

1.1 Background of the Study 1

1.2 Statement of the Problem of Study 2

1.3 Objectives of the Study 3

1.4 Research Questions 3

1.5 Statement of Hypotheses 3

1.6 Scope of the study 4

1.7 Significance of the Study 4

1.8 Structure of the Study 5

LITERATURE REVIEW ON EXTERNAL DEBT AND GROWTH 6

2.1 Introduction 6

Economic development is the process of increasing the living standards of people within the boundaries of a specific location through the efficient and sustainable allocation of scarce resources (Kondonassis, A.J, 1991) .Conventionally, economic development can also be used to mean economic growth with structural change. This means that economic growth is a basic requirement for economic development. It should be noted, however, that while economic development concentrates on the transformation of economic structures and institutions, the study of economic growth emphasizes on the use of mathematical models that describes the quantitative relationships between economic variables. Academic studies on external debt related issues and its impacts on growth have only exploded after the debt crisis that hit many developing countries in the early 1980s. This chapter presents some relevant literature on growth and external indebtedness in developing countries. 6

2.2 Impact of External Debt on Growth and Development 7

EXTERNAL DEBT AND ECONOMIC GROWTH IN THE ECOWAS 13

3.1 A Brief Economic History of the ECOWAS Countries 13

3.3 Summary and Conclusions 14

DATA AND METHODOLOGY 16

EMPIRICAL RESULTS 23

5.1 Introduction 23

5.2 Unit Root Tests 23

5.2 Co Integration Analysis 25

The rationale of the co integration test is to determine whether a group of non –stationary series is co-integrated or not, as it is discussed in Chapter 4, if any two time series Xt and Y t are both I (1), and if error term, et (the residuals of the time series), which is defined as et =Y- β X t, is I (0), then Xt and Yt are said to be co-integrated. 25

5.2.1 Johansen Co Integration Test Results 25

5.4 Error Correction Model (ECM) 27

CONCLUSION AND RECOMMENDATIONS 30

6.1. Conclusion 30

6.2. Recommendation 31

LIST OF TABLES

LIST OF FIGURE

INTRODUCTION

1.1 Background of the Study

The debt burden issue on less developed countries can be traced to the early 1980’s after the oil price increase of the 1970’s. It was the product of reactions by the international community to “oil price shocks”. One of the legacies of Economic Community of West African State (ECOWAS) countries from the crisis has been an increasing debt stock and debt service payments, which constituted a major constraint to economic growth and social development (Elbadawi, et al. 1996).

In addition, Elbadawi, et al. (1996) maintain that ECOWAS countries spending on debt servicing was about one third of its public budget, which was about three times its education expenditure and nine times the health funds on servicing outstanding debts. They note that ECOWAS countries were only paying diminutive over half its planned debt service. Grants from contributor countries were then one-hundredth of the worth of debt service. The truth is that there was a lattice transfer of funds from ECOWAS countries to the developed countries.

Furthermore, according to Semenitari (2005), states that African countries’ especially ECOWAS countries was owing over an estimated overall foreign debt of US$28.347 billion as at December 31, 2001, consisted considerably of amount outstanding of principal, interest, as well as late interest, which have been consolidated to structure the current principal balance. So, one could view the negative effect not only of principal and interest arrears, but also of late interest which is interest charge on defaulted debt service payments. The specter that emerges from the dynamics is that of a problem of rising debt burden which if not arrested, would continue to invalidate not only debt service efforts but also efforts made to reinstate the economy to the pathway of recovery and growth.

However, given the number of years, since African countries had been independent and the substantial debt its had incurred, coupled with the existing institutions, one can claim that the entire spectrum of the economy has not been sufficiently active, especially when compared with the economy of similar or lesser aged developing countries.

1.2 Statement of the Problem of Study

The huge foreign debt accumulation and debt service of ECOWAS countries prevented the ECOWAS Countries from embarking on larger volume of domestic investment, which would have enhanced growth and development (Clements, etal. 2003). External debt became a problem to most African countries because contracted loans were not optimally utilized, therefore returns on investments were insufficient to meet maturing obligations and did not leave a good balance to support domestic economic growth. So, African economies have not performed well, partly because of the bigger outflow of resources to service debt and partly because the essential macro-economic modification has remained intangible for most of the ECOWAS countries. The main interest of this study is to empirically explore effect of huge external debt volume and debt servicing on the ECOWAS countries economic growth.

1.3 Objectives of the Study

The study will focus on the following objectives:

Examine the pattern of the external debt trend of the ECOWAS countries from 1970 to 2008?

To what extent is the impact of external debt and debt on the economic growth of the ECOWAS Countries.

1.4 Research Questions

The main research question would be considered in the course of the study:

The trend of the external debt trend of the ECOWAS countries in the past?

Is the impact of external debt and debt servicing on the ECOWAS Countries economic growth.

1.5 Statement of Hypotheses

HYPOTHESIS I

Ho: That the external debt stock did not affect the economic growth of ECOWAS Countries.

Hi: That the external debt stock affected the economic growth of ECOWAS Countries.

HYPOTHESIS II

Ho: That the external debt service payment did not have impact on the economic growth of ECOWAS Countries.

Hi: That the external debt service payment had impacted on the economic growth of ECOWAS Countries.

1.6 Scope of the study

The scope of this study shall cover the external debt trend of ECOWAS Countries over the period to date. The general overview of the debt cancellation shall be taken with certain issues raised and discussed.

However, the empirical investigation of the effect of external debt on the economic growth of ECOWAS Countries shall be restricted to 1970 and 2008. This restriction is unavoidable because of insufficient data.

1.7 Significance of the Study

As a consequence of the increasing external debt and debt servicing, serious awareness by the ECOWAS Countries’ government and citizens have given to the issue of external debt, it therefore became necessary to assess the effect of external debt and its servicing on the economic growth of ECOWAS Countries using an econometric analysis .In addition most of the discussion has been centered on the relevance of debt cancellation to the ECOWAS Countries economy.

Given the above, the rational for the study is to examine, the economic specific implication of the external debt in ECOWAS Countries and to fill specific gap in the literature.

1.8 Structure of the Study

This study shall contain six chapters. The introductory chapter will be followed by chapter two which will give the brief historical background information of external debt, impact on external growth and development. This chapter will try to provide a theoretical basis for the study. Chapter three shall outline short economic history of ECOWAS and its debt crisis, where chapter four shall focus on the data and methodology to be adopted for the study. Chapter five shall present the results while chapter six will conclude by policy and with the appropriate recommendations.

LITERATURE REVIEW ON EXTERNAL DEBT AND GROWTH

2.1 Introduction

Economic development is the process of increasing the living standards of people within the boundaries of a specific location through the efficient and sustainable allocation of scarce resources (Kondonassis, A.J, 1991) .Conventionally, economic development can also be used to mean economic growth with structural change. This means that economic growth is a basic requirement for economic development. It should be noted, however, that while economic development concentrates on the transformation of economic structures and institutions, the study of economic growth emphasizes on the use of mathematical models that describes the quantitative relationships between economic variables. Academic studies on external debt related issues and its impacts on growth have only exploded after the debt crisis that hit many developing countries in the early 1980s. This chapter presents some relevant literature on growth and external indebtedness in developing countries.

2.2 Impact of External Debt on Growth and Development

The economic literature of recent times on open economies shows that rational levels of external borrowing by a developing country can improve its economic growth through capital accumulation and efficiency growth. This leads to faster convergence of per capita income between nations (Barro et al. 1995; Pattillo, Poison and Ricci, 2004). Most modern economies are virtually floating on credit. The accumulation of external debt is common phenomenon of developing countries at the stage of economic development where the supply of domestic savings is low, current account payment of deficit are high, and import of capital are needed to augment domestic resources (Michael, P.Todaro and Stephen C. Smith (2009) All these have made external borrowing a necessity.

2.3 Impact of External Debt, External Debt Service, Crowding Out on Growth

Cohen’s (1993) outcome on the correlation between investment Developing Countries debt in the 1980s showed that the stock of debt does not give full details the decelerate of investment in developing countries in the 1980s. It is the concrete flows of net transfers that matter. He establish that the real service of debt ‘crowded out’ investment.

Boyce and Ndikumana (2002) noted that debt burden forced Sub-Sahara African (SSA) countries to avert scarce resources from essential necessities. They further argued that the failure of many SSA countries to meet their social needs and escape from debt is, as a result of the verity that the borrowed funds have been unproductively.

Clements, et al. (2003) also confirmed that debt affect growth via its effect on the efficiency of resource use, rather than through its discouraging effect on private investment. The same study also institute that the public debt does not slow down public investment but debt service does.

Elbadawi, et al. (1996), also assert that debt servicing also affect growth in some way through their effect on public sector spending. As economic circumstances deteriorate, governments discover themselves with fewer funds and public expenses are reduced. A fraction of this spending destined for social sector has severe effects on the very poor.

If foreign resource is to be balanced and desirable, it must be primarily be used to generate enough resources in the future for the repayment of principal and interest that is due (Comeliau, 2005).

Furthermore, the external debt and growth literature suggests that there is a unidirectional causal linkage connecting indebtedness and growth (Choudhry and Arvin, 1998). De Pinies (1989) focuses on debt sustainability and adjustment, and argues that as the international credit market imposes severe credit rationing on the heavily indebted Low Income Countries (HILICs), they were in effect imposing excessive import restraints, which is one of the major obstacles to a debtor country’s growth prospects. Selowsky and Tak (1986) indicate that since heavily indebted low-income countries have been servicing their debt by squeezing imports and investments to generate trade and equivalent saving surpluses, they have also been paying a high price in terms of forgone consumption and output growth.

2.4 Impact of External Debt, External Debt Service, Debt Overhang on Growth

The beneficial impacts of foreign borrowings on the economies of developing countries such as the ECOWAS countries, in the 1970s have been questioned by policy makers have had doubts about external borrowing. Neither the assumed positive effect of foreign borrowing on the level of savings, nor the presumed growth is supported by empirical evidence.

For example, Borensztein (1990) discovered that debt overhang had a negative impact on private investment in Philippines. The impact was high when private debt rather than total debt was employed as a determinant of the debt overhang. Iyoha (1996) establish related results for SSA countries. He established that high and unsustainable level of debt acts to reduce investment through both the debt overhang and the ‘crowding out’ effect.

Elbadawi, et al. (1996) also examine the consequences of debt overhang effect on economic growth using cross-section regression for 99 developing countries spanning SSA, Latin America, Asia and Middle East. They initiate that debt growth reduces economic growth while debt stock stimulates economic growth. Their results also showed that the debt burden has led to fiscal agony as manifested by harshly compacted budgets.

Mbanga and Sikod (2001) confirm that debt overhang and crowding out impact on private and public investments respectively using Cameroon as a case study. However, similar studies discovered a negative effect of external debt on growth for example, Degefe (1992). Other academic studies show the impact of the debt burden indicators on economic growth under different scenarios using the simulation analysis (e.g. Ajayi, 1991 and Osei, 1995).

Ojo, (1996) affirms that it is no exaggeration to claim that Nigeria’s huge external debt is one of the hard knots of the Structural Adjustment Programme introduced in 1986 to put the economy back on as sustainable path of recovery. The corollary of this statement is that if only the high level of this debt service payment could be reduced significantly, African countries would be in a position to finance larger volume of domestic investment, which would enhance growth and development. But, more often than not a debtor has only a limited room to manage a debt crisis to advantage.

Were, (2001) noted that Sub Sahara Africa countries were plagued by their huge external debt. Were, argued that the debt problem, caused by massive poverty affected the economic prosperity. It then became crystal clear that countries with unsustainable level of debt require debt relief to experience rapid economic performance.

Omoruyi, (1992) state as result of shortage of domestic savings, external borrowings have become the only feasible option to fill such gaps. Conversely, mismanagement of foreign loans could result to the problem of servicing them and eventually might leads to the problem of debt overhang.

Sun, (2004) opined that completion point countries should sustain sound macroeconomic stability and reforms to improve policy and institutional frameworks to achieve both development and to maintain debt sustainability. Sun, concludes there is an existence a mix results between debt and grant financing to actualize of the Millennium Development Goals.

Ngassam (2000) argued that debt obligations can be eased temporarily by rescheduling. Ngassam concluded that because of the structural difficulties facing most African countries, an ideal policy package for managing external debt has to aim at the structural problems. This goes to tell us that the impact of external debt in the developing countries is nothing to desire.

In view of the fact that these countries cannot be expected to sustain such policies for very long, Selowsky and Tak advocate a growth-oriented debt policy wherein creditors provide new financing, at least until the structural adjustment program take effect. Roubini (1985), Sachs (1985), Kaminarides and Talbert (1989), and Kaminarides and Nissan (1993) all examined the consequences of debt within a multi-country framework. Their studies suggest that at the aggregate level, debt adversely affect economic growth and the causality is a uni-directional one, that is, growth is adversely affected by a higher debt burden.

2.5 Impact of External Debt and Servicing On Growth – A Two Variable Case

As Farhang Niroomand and Iskandar S. Hamvi, “effects of foreign debts on the economic performance of small countries effect using correlation analysis for Forty-eight small countries spanning Africa, the Caribbean region, Latin America, the Middle East, and Europe. They found that the economic impact of external debt varied among countries on different socio-economic factors such as income level and geographical locations.

Ramakrishna (2003) studied the external debt scenario of Ethiopia over its three economic regimes with a special reference to its economic reform period. The study also confirmed the debt-growth. The trends in external debt in different administration indicate that Ethiopia has been a severely indebted Africa Country. According to Ramakrishna (2003), despite rescheduling and other policy measures, the Ethiopia has not been able to meet its debt service obligations. Debt amount outstanding have increased thereby increasing Ethiopia’s debt.

2.6 Summary and Conclusions

This chapter reviewed some of the existing literature on the linkage between external debts, debt servicing and economic growth in developing countries. The chapter finally reviewed the theoretical literatures that assessed the effects of external debt and debt-service on economic growth in third World countries.

The issue of economic growth is of great importance to any nation state because it is the country’s total output that determines the general welfare (per capita income) of the citizens. As the explosion of the debt crisis in the 1980s, many scholars have written extensively on the nexus of external debt and growth in developing countries. Therefore, these countries can borrow to augment their limited domestic capital and hence promote growth and development through productive investments. Once growth is achieved, the returns of the invested resources should be used to service the debt.

However, many recent empirical studies on developing countries shows that external borrowing, instead of positively promoting economic growth, it retards growth. This is because high external indebtedness discourages the inflow of foreign capital in the form of investment for fear of ill macroeconomic policies that distort the economy. Debt-service, which is the immediate impact of large external debt, drains the debtor countries of resources that could be invested to promote growth. These studies are largely based on individual countries only. From evidence of the reviewed of the literature, the researcher concludes that the impact of external debt and servicing is different for different nations and literature shows that there is need for a more comprehensive study on the subject matter using ECOWAS as a case study this study aims to fill this gap.

EXTERNAL DEBT AND ECONOMIC GROWTH IN THE ECOWAS

3.1 A Brief Economic History of the ECOWAS Countries

The ECOWAS was set-up on 28 May 1975 when fifteen Heads of States of West African countries signed the treaty establishing it at Lagos, Nigeria. It now comprises sixteen members with different levels of economic growth and resources. The selected basic macro economic characteristics of theses countries are shown in Table 1.

As Table 1 indicates, ECOWAS spans a West African territory with 287.45 million inhabitants. Per capita income ranges from US $ 222 for Liberia to US $3193 for Cape Varde. Figure 1 show, the Gross Domestic Product, external debt, debt service, inflation, current account balance, nominal interest rate, and public budget deficit in 2005 of each of the ECOWAS share in 2008

According, to the articles of the Treaty of ECOWAS the community aims at promoting cooperation and development in the fields of industry, transport, telecommunication, energy, agriculture, natural resources, commerce, monetary and financial relations and socio-cultural matters.

3.2 Members States: Benin, Burkina Faso, Cabo Verde, Cote d'Ivoire, The Gambia, Ghana, Guinea, Guinea Bissau, Liberia, Mali, Mauritania, Niger, Nigeria, Senegal, Sierra Leone and Togo. Following the withdrawal of Mauritania in 2001 there are now fifteen (15) Member Stares making up the community.

Figure 1: GDP Share of each ECOWAS countries in 2008

3.3 Summary and Conclusions

This chapter described in brief the uniqueness and economies of the Economic Community of West African States (ECOWAS) and presented their basic economic indicators as indicated in table 1.

In conclusion, ECOWAS economies are complex set of economies whose economic growth trajectories are difficult to predict due to their vulnerability to both internal and external factors. Although they share many common characteristics, however, they also have distinct differences in their economic and natural resource endowments. To generate sustainable growth, these countries need to address the various factors that affect their growth prospects.

Table 1: Selected Main Macroeconomic Indicators of ECOWAS 2008

Country

Population

(millions)

GDP

(Billions US$)

GDP

per capita US$)

GDP

Growth (annual %) (2004-2008)

Current account balance

Public Budget Deficit

(2005)

External Debt

Total

debt

service

Inflation 2004-2008) average

Nominal interest rate (%)

(2004-2008)

Benin

8.6

6.6

771.2

3.9

-2.4

14.8

7.9

3.8

Burkina Faso

15.2

7.9

521.7

4.9

-5.3

21.1

10.6

3.7

Cape Verde

0.5

1.5

3193

5.1

-12.9

-3.7

36.6

3.4

6.7

10.2

Cote d'Ivoire

21

2.3

1137

1.5

2.08

-1.7

55.9

9.2

6.3

3.1

Gambia

1.6

81

488

6.1

-5.35

-8.6

61.5

4.4

30.1

Ghana

23

16

713

6.1

-21.2

-1.6

31.3

3.2

16.5

13.1

Guinea

9.8

3.7

386

2.8

-11.4

-0.9

73.2

9.6

18.3

3.6

Guinea-Bissau

1.5

0.4

272

2.4

-11.9

274.0

10.4

4.2

Liberia

3.7

0.8

222

6.4

-140.9

0.9

515.4

131.3

5.7

Mali

12.7

8.7

687

4.2

-3.1

25.8

9.1

3.0

Niger

14.7

5.3

364

5.0

-1.6

18.0

11.3

3.8

Nigeria

151

207

1369

6.9

19.0

9.4

5.6

11.5

13.7

Senegal

12.2

13

1086

4.4

-3.2

21.8

5.7

3.1

Sierra Leone

5.5

1.9

351

-11.6

-1.7

20.3

17.4

16.0

Togo

6.45

2.8

448

2.2

-3.0

56.0

8.6

3.8

Total

287.45

Source: World Development Indicator (WDI)

DATA AND METHODOLOGY

4.1 Introduction

This study is performed in the framework of ECOWAS countries, for the period 1960 to 2008. Data sources are the World Development Indicators (WDI) of the World Bank (2009) in annual figures. In this study, economic growth is measured by Gross Domestic Product (GDP) constant 2000 US$ while external debt stock (EDS) and debt servicing (DS) will be the independent variables. All variables are at their natural logarithms and EVIEWS 6.0 is the software package used for calculation of our results.

4.2 Data Description

The main variables for this study include external debt stock, debt servicing and GDP at Constant US Dollars prices. Due to large missing numbers of observations of data on World Development Indicator Database, following ECOWAS countries were excluded. These countries are: Cape Varde, Guinea, Liberia, Mali and Senegal.

4.2.1 Gross Domestic Product (GDP)

The Gross Domestic Product (GDP) is widely used to measure economic growth. Based on the fact that there is correlation between external debts, debt service payment and economic growth.

4.2.2 External National Debt

External national debt is that portion of national debt owed to non-resident foreign creditors or country [1] . It is otherwise known as foreign debt.

4.2.3 Debt Servicing

This is the payment of interest on a debt and of such installments of the principal is legally due [2] .

4.2.4 Economic Growth

Economic growth can be defined as the growth of the economy as measured by the increase in the GDP in real term over time. An increase in the GDP means that more goods and services are being produced in the current period when compared to the prior period. Such increases are due to increase in productivity or increases in the factors of production [3] .

4.3 METHOD OF ANALYSIS

The method of analysis to be used shall be the time series data econometrics. This approach, which is a quantitative technique, includes table and the test for the hypotheses formulated by using time series data econometric regression analysis .In demonstrating the application of the time series data econometrics method, the regression analysis would be used with the GDP as the dependent variable in both models. The explanatory variables are external debt service payment and external debt stock.

4.4 MODELS SPECIFICATION

The models to investigate the effect of external debt and external debt servicing on the economic growth of ECOWAS with the dependent variable as gross domestic product while the explanatory variables are external debt service payment. So that:

MODEL

gdp = f (eds, ds)

Where gdp - Gross Domestic Product

eds - External debt stock

ds - Debt service payment

4.5 METHODOLOGY

The method employed for construction, estimation and analysis will be econometric models. The model attempt to investigate the relationships between the external debt and servicing and economic growth of each ECOWAS countries using an annual time series data for each ECOWAS (1960 to 2008), The following tests will be conducted in the estimation of individual country data of the ECOWAS countries: ADF and PP Unit root test, Johansen – Juselius Co-integration test and Error correction Model.

4.6 UNIT ROOT TESTS

Prior to econometric modeling estimates and in to order to empirically test for co-integration between economic growth, external debt stock and servicing variables there is a need to examine, as an initial step, if series are integrated and have a unit root by using Augmented Dickey – Fuller(ADF) (1979) and Phillips- Perron tests (PP). Phillips and Perron (1988) propose a non parametric method of controlling for higher –order serial correlation in a series. Thus, the test regression for the Phillips- Perron (PP) test is the AR (1).

The PP test makes an adjustment to the t-statistic of the coefficient from the AR(1) regression to account for the serial correlation in εt .The Augmented Dickey-Fuller (ADF) (1979) and Phillips –Perron (PP) unit root test is used in examining the stationary nature of the data series and test the null hypothesis that a time series is I(1). It consists of running a regression of the first difference of the series against the series lagged once, lagged difference terms, and optionally, a constant and a time trend. This can be expressed as:

Δyt = β1yt-1 + β2Δyt-1 + β3Δyt-2 + β4 + β5t (1)

The test for a unit root is directed on the coefficient of yt-1 in the regression. If the coefficient is considerably different from zero then the hypothesis that y contains a unit root is rejected. Rejection of the null hypothesis implies stationarity. If the calculated ADF statistic is greater than McKinnon's critical value then the null hypothesis is not rejected and it is concluded that the considered variable is non-stationary, i.e. has at least one unit root. Then, the testing is re-applied after transforming the series into first differenced form. If the null hypothesis of non stationarity can be discarded, it can be concluded that the time series is integrated of order one, I (1).

4.7 CO-INTEGRATION TESTS

After the order of integration is determined in the data, co-integration between the series should be tested to identify any long run relationship. “Co-integration means that despite being individually nonstationary a linear combination of two or more time series can be stationary” (Guajarati, p.730). Co-integration is the statistical proposition of the existence of a long term relationship between economic variables (Thomas, 1993). Johansen test is used to identify co –integrating identifies co-integrating relationship among the variables. Some authors (Cheung and Lai, 1993) point out that trace test gives better results and is more robust than maximum eigenvalue test for co-integration.

Co-integration of two or more time series suggests that there is long term, or equilibrium relationship between them and to avoid the risk of spurious regression. It can be assessed via unit root test on the residuals of the regression. Co-integration analysis is important because if two non-stationary variables are co-integrated, a VAR model in the first difference is misspecified due to the effect of a common tend. If co-integration relationship is identified, the model should include residuals from the vectors (lagged one period) in the dynamic Vector Error Correcting Mechanism (VECM) system.

4.7.1 Johansen co-Integration Tests

The Johansen trace tries to determine the number of co-integrating vectors among variables. Under the trace test, the null hypothesis that there are at most r co-integrating vectors(r=0) is tested against the alternative that (r≤ 0) where r equals the number of co-integrating vectors. For existence of co-integration there should beat least one co-integrating vector.

This method provides the maximum likelihood estimates of the long run co-integration relationships between variables. “The possibility to have multiple long run relationship is first investigated by Johansen and Juselius in 1990” (Kulendran and Witt, 2000).

With the help of E-View 6 software, the log –likelihood ratio statistic for statistics for determining the number (r) of long run relationship between variables can be determined. If the calculated value of the statistics is greater than the 95% critical value, the null of r =0, which indicates no relationship, is rejected against the alternative hypothesis. Rejection of null hypothesis shows that there is long-run relationship between variables.

In this stage, Johansen co-integration test is used to spot co-integrating relationship among the variables. The Johansen multivariate co-integrating structure, the following system is estimated:

Δzt = Π1 Δzt-1 + …+ Πk- 1 Δzt-k-1 + Пzt-1 + μ + ET: t =1, T (2)

Where Δ denote the first difference operator, z denotes vector of variables, εt ~ niid (0, Σ), μ is a drift parameter, and Π is a (p x p) matrix of the form Π = αβ’, where α and β are both (p x r) matrices of full rank, with β containing the r co-integrating relationships and α carrying the equivalent adjustment coefficients in each of the r vectors. Johansen (1995) proposes two tests statistics to decide the co-integration rank.

4.8 Error Correction Model (ECM)

“Error Correction Model (ECM) is developed by Engle and Granger (1980), which means the reconciliation of the short run behavior of an economic variable with its long run behaviour” (Guajarati, p.730). Actually, it means the correction of error disturbances between disturbances between long –run and short run demand dynamics.

ECM can be estimated when YT and Xt are nonstationary, but co-integrating. One way to estimate the error correction model is to use least squares to estimate the co-integrating relationship y=β + β2 xt , and to then use the lagged residuals e t-1 = yt-1 – b1 – b2 xt-1 as the right hand side variable in the error correction model through estimating it with a second least squares regression.

Chapter 5

EMPIRICAL RESULTS

5.1 Introduction

This chapter will provides both the interpretation and the explanations of the results from the test employed to the data defined for the ECOWAS countries.

5.2 Unit Root Tests

The accepted method to test the unit root for stationarity of variables and settle the degree of integration of a time series is to apply the Augmented Dickey Fuller (ADF) and Phillips- Perron (1988) tests. Therefore, these tests for unit root process at the level and at the first differences of all variables have been performed and reported in Table 1.

According to, Table 1, ADF and PP unit root test reveals that GDP, External debt stock and debt Service are all the time series are I(1). However, Cape Varde, Guinea, Liberia, Mali, Senegal as omitted because they have a missing data of more than 20 years.

Table 2: Unit Root Tests for Individual Countries Variables

Countries

Variables

ADF

PP

Conclusion

Benin

GDP

I (1)

I(1)

I(1)

Debt Service

I(1)

I(1)

I(1)

Debt Stock

I(1)

I(1)

I(1)

Burkina Faso

GDP

I(1)

I(1)

I(1)

Debt Service

I(1)

I(1)

I(1)

Debt Stock

I(1)

I(1)

I(1)

Cote d'Ivoire

GDP

I(1)

I(1)

I(1)

Debt Service

I(1)

I(1)

I(1)

Debt Stock

I(1)

I(1)

I(1)

Gambia, The

GDP

I(1)

I(1)

I(1)

Debt Service

I(1)

I(1)

I(1)

Debt Stock

I(1)

I(1)

I(1)

Ghana

GDP

I(0)

I(1)

I(1)

Debt Service

I(1)

I(1)

I(1)

Debt Stock

I(1)

I(1)

I(1)

Guinea-Bissau

GDP

I(1)

I(1)

I(1)

Debt Service

I(1)

I(1)

I(1)

Debt Stock

I(1)

I(1)

I(1)

Niger

GDP

I(1)

I(1)

I(1)

Debt Service

I(1)

I(1)

I(1)

Debt Stock

I(1)

I(1)

I(1)

Nigeria

GDP

I(1)

I(1)

I(1)

Debt Service

I(1)

I(1)

I(1)

Debt Stock

I(1)

I(1)

I(1)

Sierra Leone

GDP

I(1)

I(1)

I(1)

Debt Service

I(1)

I(1)

I(1)

Debt Stock

I(1)

I(1)

I(1)

Togo

GDP

I(1)

I(1)

I(1)

Debt Service

I(1)

I(1)

I(1)

Debt Stock

I(1)

I(1)

I(1)

Source: World Development Indicator (WDI)

Having found out that the time series are I (1), co-integration analysis can be considered to identify the long run relationship between Gross Domestic Product, External Debt Stock and Debt servicing. To perform the standard co-integration test, all economic variables in the model must have the same order of integration (Kulendran, 1996).

5.2 Co Integration Analysis

The rationale of the co integration test is to determine whether a group of non –stationary series is co-integrated or not, as it is discussed in Chapter 4, if any two time series Xt and Y t are both I (1), and if error term, et (the residuals of the time series), which is defined as et =Y- β X t, is I (0), then Xt and Yt are said to be co-integrated.

5.2.1 Johansen Co Integration Test Results

The Johansen co-integrated provides the log likelihood ratio statistics for determining the number (r) of long run relationship between GDP, EDS and DS. If calculated value of the statistics (Johansen trace test statistic) is greater than 95% critical value, the null of r= 0, which indicates no long term relationship, is rejected against the alternative hypothesis.

Now that we have established that GDP, EDS and DS are non stationary at level and integrated to the same order me (1), we can test for the presence of co-integration.

Table3: Johansen Co-integration and Error Correction Test Results

Countries

Model

Optimum Lag

Johansen Trace Test

Level equation

ECM [t-ratio]

Benin

GDP=f(EDS,DS)

3

36.47*

1.0

-0.63

EDS

0.10 [4.42]*

[-4.93]*

DS

-0.03[-1.47]

Burkina Faso

GDP=f(EDS,DS)

2

30.92**

1.0

-0.16

EDS

-1.32 [7.65]*

[-1.93]***

DS

1.07 [5.58]*

Cote d'Ivoire

GDP=f(EDS,DS)

2

33.52**

1.0

-0.06

EDS

-0.20[-7.93]*

[-2.1]

DS

0.20 [6.59]**

Gambia, The

GDP=f(EDS,DS)

1

48.98*

1.0

-0.06

EDS

-1.20[-7.93]*

[-2.1]

DS

0.85 [6.59]*

Ghana

GDP=f(EDS,DS)

2

32.09**

1.0

-0.94

EDS

-0.71 [-9.32]**

[-1.92]***

DS

0.48 [21.96]*

Guinea-Bissau

GDP=f(EDS,DS)

1

35.58**

1.0

-0.138

EDS

-0.37 [2.76]**

[-2.81]**

DS

0.46 [-3.66]*

Niger

GDP=f(EDS,DS)

1

33.25**

1.0

-0.40

EDS

0.13[3.55]*

[-3.02]*

DS

-0.16 [-3.66]*

Nigeria

GDP=f(EDS,DS)

1

41.45*

1.0

-0.21

EDS

-0.05 [-2.37]**

[-1.92]***

DS

0.14 [5.61]*

Sierra Leone

GDP=f(EDS,DS)

4

30.15**

1.0

-0.09

EDS

-1.36 [-3.08]

[-3.06]*

DS

0.24 [0.67]*

Togo

GDP=f(EDS,DS)

4

32.25**

1

-0.20

EDS

-0.18 [-1.39]

[-2.37]**

DS

0.17 [2.18]*

Source-World Bank Development Indicator (WDI)

*, ** and *** denotes statistical significance respectively at 0.01, 0.05, and 0.10 levels of alpha. Optimum Lags are selected by Akaike information Criterion. Figures in parenthesis are t-ratio.

The Johansen co-integration test results are reported in Table 2. Results indicates that there is long run relationship between GDP, external debt stock and servicing in the above 10 ECOWAS countries since the calculated value of the statistics is greater than 5% critical value.

5.2.2 Estimated Long Run Relationship between External debt and Debt servicing on the ECOWAS countries Economic growth

Table 2 reports the co-integration analysis results for the ten countries in the ECOWAS countries. The coefficient estimates for the debt service are negative for Benin and Niger but and statistically significant for only Niger while it have not adverse effect on the remaining ECOWAS countries.

However, external debt stock coefficients are negative and statistically significant for Benin, Cote d’Ivoire, Gambia, Ghana, Guinea-Bissau, Niger, Nigeria but not for Sierra Leone and Togo respectively.

5.4 Error Correction Model (ECM)

This section provides the results of the error correction models for the GDP, external debt stock plus debt serving for the above ten ECOWAS countries. According to ADF and PP test the series are stationary and the order of integration of times series are I (1).

The optimum lags orders are selected by Akaike Information Criterion. The error correction term used in the error correction model is obtained from the estimated long-run relationship.

Estimated short-run external debt-growth models for Benin, Burkina Faso, Cote d'Ivoire, Gambia, Ghana, Guinea –Bissau, Niger, Nigeria, Sierra Leone and Togo are represented in Table 2 page 30. . The ECM coefficient estimates for the debt variables are all negative (as expected) and statistically significant suggesting the adverse effect that foreign indebtedness is having on these economies.

5.5 What is the pattern of ECOWAS countries of external debt stock in the past?

This section will intend to link the external debt stock with the results of the test made.

Figure 2: The Graphical Trend of ECOWAS Countries External Debt Stock

As can be seen from Figure 2 above, trend in external debt stock for ECOWAS countries are quite similar and parallel to each other over the years. The movements are approximately the same. Thus, our findings that external debt stock serves one as the main catalyst of economic growth for the ECOWAS countries in the short run in Table 3 is also reasonable according to Figure 2 as well.

5.6. What is the impact of External debt and servicing on the ECOWAS Countries economic growth?

The ECM analysis examines the long term level relationship between the external debt stock, debt servicing and the gross domestic product of the each ECOWAS countries. It was revealed that there is a significant long term relationship between the variables. Besides, external debt stock was found to be positive in Benin, Niger but negative in Burkina Faso, Cote d’Ivoire, Gambia, Guinea- Bissau, Nigeria, Sierra-Leone and Togo.

As indicated by the ECM analysis in Table 3. This is consistent with the findings in level equation results in Table 3. The results indicate the existence of a bi- directional linkage between external debt stock, debt servicing and economic growth equations. These results tally with similar results with similar studies (Elbadawi, et al. 1996, Farhang Niroomand and Iskandar S. Hamvi 1996 and Mbanga & Sikol, 2001)

The estimation results for the ECOWAS countries identified external debt stock deter economic but also debt servicing. The error correction results also shows that external debt stock and debt servicing have negative impact on the economic growth of the ECOWAS countries This is because money that ought to be available in the economy are removed and used to service external debt; this would hinders productivity since the needed fund to embark upon production activities and expansion have been withdrawn.

In conclusion, the potentially important contributors to the slowdown of ECOWAS countries economic growth have been the adverse effect of external debt and debt servicing. This study has empirically evaluated empirically the link between debt servicing payments and the ECOWAS external debt stock. As a result of the Error Correction testing procedure, strong evidence emerges that external debt stock and debt servicing has an impact on the economic growth of ECOWAS countries. This finding suggests that external debt stock and servicing may be important factor in determining economic growth in ECOWAS region.

Chapter 6

CONCLUSION AND RECOMMENDATIONS

6.1. Conclusion

External debt is one of the main sources of financing for ECOWAS countries. Rapid increase has been observed in the external debt stock within the period of the study. Viewed in this light, ECOWAS countries should borrow from external sources only when the projects are to be financed are expected to be productive. This study, therefore try to help policy makers in the composition and management of future external debt profiles.

This research studied the effect of external debt and debt servicing on economic growth of ECOWAS countries. This study examined the impact of external debt stock and servicing on the ECOWAS countries. Annual time series data for Gross Domestic product, external debt stock and debt servicing for the period 1960-2008 are analyzed.

Since the data used in the study is an annual data ADF and PP unit root test was applied. The important thing here is the existence of a long-term relationship between variables. Since there is an existence of long term relationship between variables then the short run external debt model must be constructed. The short-run external debt models are estimated through ECM by applying necessary seasonal filters to the series and by taking the first difference of the series. Moreover, appropriate lag intervals of the variables was taken until the satisfactory t-statistics was obtained. The error correction term used in the error correction model is obtained from the estimated long –run relationship. In the all ECMs the sign of the residuals are all negative, which is consistent with the theory. However, t-statistics of the model was significant.

The empirical estimates gave a chance to see the impact of changes of external debt stock and debt servicing on the economic growth on Benin, Burkina Faso, Cote d’Ivoire, Gambia, Guinea- Bissau, Niger, Nigeria, Sierra-Leone and Togo.

6.2. Recommendation

The suggested policy recommendations are as follows: ECOWAS countries need to channel its future external borrowings into productive programs, in which the ECOWAS countries has comparative advantage rather than engaging white elephant programs. This would enable the ECOWAS countries to generate a reasonable amount of money for debt repayment.

Finally, they must embark on a practical debt management policy now, along with maintenance of macroeconomic stability and favorable business climate.


Request Removal

If you are the original writer of this essay and no longer wish to have the essay published on the UK Essays website then please click on the link below to request removal:

Request the removal of this essay


More from UK Essays