Impact of External Debt on Economic Growth: Evidence from Ethiopia Using an Autoregressive Distributed Lag model Approach

Abstract

Debt overhang is the current Ethiopian principal challenge that creates underinvestment problem. Thus, the debt burden incurred deteriorates economic growth of the country. The main objective of the research was to examine the impact of external debt on economic growth in Ethiopia using annual data for period of 1981 to 2022 from National Bank of Ethiopia, Central Statistics Authority of Ethiopia, International Monetary Fund and the World Bank Database. The study employed Autoregressive Distributed Lag approach to analyze the impact of external debt on economic growth. The result of the study revealed that the bounds co integration test approach shows the presence of long run equilibrium relationship between the variables under consideration. In long run, the empirical growth equation revealed that external debt stock as a percentage of Gross National Income has a significant positive impact on economic growth in the long run; whereas its square has a significant negative impact with economic growth implying that there is a non-linear relationship between economic growth and external debt stock. The capital outflow (total debt service) which is needed to service external debt for country has negative impact on economic growth both in the long run and short run. However, external debt stock has a positive impact on economic growth in the long run if it is maintained at maximum level. The error correction term value which is speed of adjustment, -0.230584 is indicate that around 23% shocks happened in short run is restored (converge) to long run equilibrium per year and confirmed the existences of co-integration among the variables under consideration. Finally, the study suggested that, government instead of heavily depend on external debt for development it must mobilize domestic resources to stimulate the domestic revenue collection process to fill country financial gap. The government should also control the level capital outflow, to reduce capital outflow for debt servicing it needs a professional and skilled negotiation with international donor agencies and countries, stimulate production and promote the development of an economy. The government should adopt targeted policies such as improved foreign exchange supervision and incentives for domestic investment to effectively manage capital outflows.