The Effect of external financing on economic growth in Uganda (1990 - 2023)

Abstract

External financing is generally seen as an important catalyst for economic growth, particularly in countries with limited domestic capital. It plays a crucial role in enabling investments that foster development, enhance productivity, and stimulate various economic sectors. However, its effectiveness depends on how well it is managed and utilized within a country’s broader economic policies and structures. This study examines how external financing affects economic growth in Uganda. It uses time series data spanning 34 years from 1990 to 2023, with all variables obtained from the World Bank's World Development Indicators (WDI). The study utilizes the Augmented Dickey-Fuller and Phillips-Perron root tests to determine the order of integration, which shows a mix of I (0) and I (1) integration. Based on this mixed order, the Autoregressive Distributed Lag (ARDL) model is employed. The study findings confirm a positive relationship between debt service, foreign direct investment, foreign remittances, institutional quality, and inflation on gross domestic product growth, aligning with previous research. However, there is a negative relationship between external debt, exchange rate, and gross domestic product growth. This finding aligns with the literature on the debt overhang theory, which suggests that when a country’s debt level becomes too high, it discourages investment and slows economic growth. The study recommends that the government should focus on improving the efficiency and effectiveness of public spending by prioritizing investments in infrastructure, education, and healthcare. Additionally, the government should ensure that new borrowing aligns with growth objectives and that debt service obligations remain manageable by prioritizing loans likely to yield high economic returns.