The effect of external debt on economic growth in East African countries

Abstract

The study analyzed the effect of external debt on economic growth in East African countries. It used quarterly panel data where gross domestic product was endogenous variable measuring economic growth as a function of capital formation, labor force, external debt stock in long-term1, real effective exchange rate, gross domestic savings as percentage of GDP proxy of investment and trade openness as percentage of GDP. The data was quarterly panel data from World Bank Development Indicators, World Bank Data Base and Bruegel Data Base from 2001 – 2015. However, the econometrics technique employed was unit root test, Hausman test with FE and RE, multicollinearity test, Autocorrelation test, and heteroskedasticity test in empirical analysis using Stata13 software. Findings: the correlation matrix shows that there is significant positive relationship between external debt and economic growth, while the other macroeconomic variables like capital formation,real effective exchange rate, domestic investment and trade openness are also positively correlated to economic growth, labor force was significant but negatively correlated to GDP. Meanwhile, GLS regression results indicates that external debt has a positive effect on economic growth as well as macroeconomic variables like REER, INV and OPEN, while CAPT and LAB have negative effect on economic growth. Policy implications: the region must open up trade with other developed nations; borrow strategically to promote domestic investment. The borrowed fund should be utilized in developmental projects and basic infrastructures in order to pay back the principal and the interest in time to avoid debt over-hang and invest the profit domestically. If debt is used for political and self-interest, East Africa will not come out of poverty and the future generations won‟t escape debt over-hang. Again, the region needs to industrialize to increase production and reduce population growth rate which is a challenge to the GDP.