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Fridays Academy : External Indebtedness, Growth and Poverty: Empirical Studies

Ignacio Hernandez's picture

Like every Friday, from Raj Nallari and Breda Griffith's lecture notes.


Notwithstanding the attractiveness of the debt overhang hypothesis as an explanation for the high debt-low growth nexus, empirical evidence of the effects of debt overhang has been mixed. For example, Claessens found that five of the 29 middle-income countries in his sample were on the wrong side of the Laffer debt curve, suggesting that partial debt reduction would increase the expected repayment to the creditors. For middle-income countries, Warner concludes that the debt crisis did not depress investment.  Several other studies have concluded that it is difficult to disentangle the impact of debt variables on growth and the role of debt overhang from other factors on growth and that debt burden can negatively impact other factors (e.g., debt can affect domestic real interest rates which can impact on investment and growth).


The second difficulty relates to the crowding out effect. Most studies on investment equations do not distinguish between these two effects. In this context, statistically significant debt variables do not isolate the debt overhang effect. To distinguish between these two effects, both contemporaneous debt service and a variable capturing the burden of future debt service such as the debt stock or the net present value (NPV) of future debt service should be included in the regression analysis.  In a recent study, Patillo et al. of IMF show that for the 93 developing countries that they examine, there seems to be a nonlinear, Laffer-type relationship between debt and growth. They find that the average impact of external debt on per capita growth appears to be negative for NPV of debt levels above 160–170 percent of exports and 35–40 percent of GDP. Furthermore, their results suggest that doubling debt levels slows per capita GDP growth by about half to a full percent.


Evolution of Average Per Capita Income, Debt and Poverty Indicators




Two main findings could be drawn when analyzing the bivariate relationship between per capita GDP, nonincome poverty indicators and debt indicators:


  • First, there seems to be a relationship between real GDP per capita and health indicators. Life expectancy  increases with real per capita GDP.

  • Second, the correlation matrix indicates that external debt burden indicators are negatively correlated with GDP per capita and life expectancy, and positively correlated with infant mortality rate, indicating possible adverse impact of indebtedness on income and health outcome indicators. These findings are confirmed by Exhibit below, which compares poverty indicators for countries with NPV of debt less than 150 percent of exports and NPV of debt higher than 150 percent of exports, and for countries with nominal debt to GDP less and higher than 40 percent. Poverty indicators appear to be worse in countries with NPV of debt to export higher than 150 percent and in countries with nominal debt to GDP higher than 40 percent.

Poverty Indicators by Income Groups (averages)




Poverty Indicators by External Indebtedness Groups (averages)