The Impact Of External Debts On Pakistan's Economic Growth

In developing countries generally the debt accumulates as domestic savings are low and the payments deficits are high, therefore import of capital is needed to utilize the domestic resources. Currently Pakistan’s economy is unstable due to unsustainable external debts. Debt burden is a great challenge for Pakistan’s economic condition. To analyze the impact of debts we should observe the trend in foreign debts. Therefore in this paper we will analyze impact of foreign debts on economic growth.

Introduction

From late 1950s current account deficit was considered normal and it was a significant source of income for developing countries. There was an environment that encouraged developing countries to borrow from foreign counties and international financial institution to enhance the economic growth. But the other side of borrowing i.e. current liabilities was ignored that is the reason why today the developing counties are facing critical debt burden. Pakistan’s economy is facing many challenges since 21st century, the greatest of which is to pay back the external debts. With the passage of time the ratio of foreign debt is increasing. Developing countries need loans to for increase in productivity and economic development. Pakistan also relies on foreign capital for economic and social development. Pakistan’s total debt reached to 115% of GDP in 2001. It is the only severely indebted low income country in South Asia. According to IMF Pakistan’s projected external debt will be $ 75 billion in 2015. This projection has raised question of debt default resulting in reduction of investment.

Significance of study

This paper will analyze the impact of foreign loans on economic growth of Pakistan. This study will make the picture clear of Pakistan’s debt level for the investors.

Limitations

This paper will be limited to the study of impact of external debt only on Pakistan’s economic growth.

Theoretical framework

Shahrukh Rafi Khan in 1997 examined the terms on which Pakistan receives aid and the impact of foreign aid and debt on economic growth. By using the Granger Causality test he found negative impact of aid and debt on3 GDP. In 1988 M.Aslam Chauduary worked on international debt and foreign dependency. He used the two gap model to identify the demand for foreign loans. He found that if the borrowings of Pakistan continue then the situation could be worse. In other words the percentages of debt outstanding, debt servicing and per capita debt outstanding will be more than the growth rate. M. Aslam Chaudhary and Anwar in 2000 studied Debt theory. They found that there are some stages of debt cycle and according tothem in its firt stage country borrows loans, generates resources and takes stand in the second stage. But if it continues borrowing in the second stage, it may have surplus and pay back the sum borrowed. They developed a debt model to analyze the debt model to analyze the debt cycle.Ishrat Hussain in July 2001 studied “Pakistan’s development challenge” by using cross sectional data from 1990-2001 and her study explains if only public sector investment increases then it will worsen the debt situation. In 2001, Muhammad Aslam Chaudhary and Sabhat Anwas worked on “Debts Laffer Curve for South Asian Countries”. According to them the rapid increase in external debts of developing countries during 1970’s had indicate the coming dangers of increase in interest and amortization payment. Rehana Siddiqui and Afia Malik in 2001, worked on “Debt and Economics growth in Asia”. In this paper they analyzed the impact of rising debts burden the impact of rising debts burden on economic growth of South Asian countries. In case of Pakistan, higher population growth rate of capital formation, and increase in debt burden are the main reasons for low rate of economic growth. Their results depict that debt indicators increased sharply in 1990s, the population growth, mismanagement of resources, loss of competition in international market and role of political groups contribute to enhance debt burden. In 1997, Shahrukh Rafi Khan examined the terms on which that Pakistan receives aid and whether its debts situation is sustainable. He found that Pakistan is heavily in debt, and the changing terms of debt will make it difficult for the country to get out of the debt trap. In 1999, Muhammad Ishfaq and M.A. Chaudhary in “Fiscal Deficits and Debt Dimensions of Pakistan” analyzed the fiscal deficit and debt of Pakistan. They found that fiscal deficit and deficits serve as cause and effects of eachothers. Their analysis based on the period from 1980-81 to 1997-98, shows that unless corrective measures are taken, the budget deficit is likely to rise. In January 2006, Abdul Waheed worked on “Sustainability and determinants of domestic Public Debt of Pakistan” he concluded his study that domestic debts show that how much debt burden a country accumulates. In 2009 Imran Sharif Chaudhary, Shahnawaz Malik and Muhammad Ramzan worked “Impact of foreign debt on savings and Investment in Pakistan”. They investigated the impact of foreign debt on savings and investment in Pkaistan using time series econometric tools for the period 1973-2006. According to the empirical results, there is no complete evidence that debts contribute favorably to the investment and savings in Pakistan. They also found that governance mechanism has a strong and significant impact on savings and investment. Nawaz Malik, Muhammad Khizar Hayar and Muhammd Umer Hayat worked on “Empirical Debt and Economic Growth: Empirical evidence from Pakistan” in 2010. They wrote that external debt is significant source of income for developing countries. They suggested that increase in external debt will decline the economy growth. As debt servicing tends to increase, there will be fewer opportunities for economic growth.

Methodology

Many studies have been done in order to understand the impact of foreign debt on growth. And every researcher who has worked on the relationship of debt and economic growth used different methods and variables. LS technique is used in this paper to analyze the impact of foreign debt on GDP growth in Pakistan.

Hypothesis

Ho= Foreign debt has a negative impact on GDP growth in Pakistan from 1973 to 1997.

HA= Foreign debt has a positive impact on GDP growth in Pakistan from 1973 to 1997.

Data and Variables

For estimation the data is used from the time period 1973 to 1997 which has been taken from site Federal Bureau of Statistics, State bank of Pakistan and Economic Survey of Pakistan. To analyze the impact of foreign debt on growth I took five variables.

Variables

Description

Source

Labor

Labor is one of the factors of production. It is the measure of work done by human being.

The data of labor was taken from world resource institute.

Debts

Debts are a sum of money that is owed or due to paid because of an express agreement.

Debt data was taken from world resource institute.

Debt servicing

It is the specific amount of money required for the repayment of interest and principal amount.

Debt servicing data was taken from world resource institute.

Investment

It is the increase in the capital stock, the purchase of financial product or other items of value for future returns.

Investment data was taken from ministry of finance of Pakistan.

Dependent Variable: GDP growth

Independent variables:

Labor

Debts

Debts Servicing

Investment

The dependent variable is used in the percentage. Independent variables are Debt is in million of dollars, debt servicing and investment is also in million of dollars, labor is in thousand of people. Independent variables were chosen to represent the economic factors that affect GDP growth.

Variables

Relation With GDP

Debt servicing

It affects negatively in long run which shows that increase debt service reduce economic growth because it reduce productive investment.

Labor

It has positive relationship with GDP. Labor increases economic growth and helps in debt service reduction.

Investment

It also affect positively. It generate employment opportunities hence boost economic growth.

Debt

Reasonable level of borrowing promotes economic growth through factor accumulation and productivity growth.

Model

The model is with expected sign of the independent variables.

GDP growth= constant +debts +labor -debt servicing +investment

Results

GDP=30900.96+0.473190debt+1.864529labour-1.335435debt servicing+0.004727i

S.E = (3786.8636) (0.158988) (0.177671) (0.629939) (0.004870)

t ratios= (-8.160043) (2.976273) (10.4942 ) ( -2.119943 ) (0.970802)

R-Square= 0.998357

R-square Adjusted =0.998028

F-statistics=3037.861 Durbin-Watson statistics=1.168089

The research shows the significant results of independent variables on GDP in Pakistan. The results depict that GDP growth and debt have positive relationship which shows that as the level of debts increases the GDP also increases through factor accumulation and productivity growth. Labor also shows positive relationship with GDP growth which means as more labor works in country it will enhance economic growth and will help in debt services reduction. Debt servicing has negative sign which depicts that GDP will decrease as we have to pay back more.

Conclusion and Recommendations

The result depicts the positive effects of foreign debts on the economic development in Pakistan. Foreign debt, on the positive side helps in boosting the GDP growth through structural transformation of the economy. Proper utilization of foreign debts increases production through investment and these investments provide employment opportunities for labor .the positive relationship with investment depicts that it increase the income and domestic savings which reduces the need for foreign borrowings. When internal resources of the country are not utilized and managed in proper way the country dependency on foreign aid increases. In the long run these debts hamper the economic growth because most of the portion of the country’s earnings is used in debt servicing which affect the GDP negatively. Debt has also a negative effect on labor productivity and investment when the major portion of production is used for debt servicing.

In this regard we would like to say that there were only inappropriate debt management government’s policies which made the debt to work ineffectively. Because policies also plays an important role in the effectiveness of foreign debt, as aid has more positive impact on the growth with good policies. On the other hand debt will not work effectively if the policies are poor. Not only good policies but the implementation of these policies as well as the proper monitoring of debt utilization are very important to avoid the poor utilization and mismanagement of foreign inflows.