Presence of Debt Overhung Effect in Pakistan: Empirical Evidence with ARDL Model

Abstract

Many developing nations, including Pakistan, have struggled with the challenge of maintaining debt sustainability due to insufficient revenue generation to meet economic crises. The primary aim of this study is to find how external debt, debt servicing, and exports influence the economic growth of Pakistan, utilizing data from 2000 to 2020. Augmented Dickey-Fuller test (ADF) is applied to evade spurious regression, revealing that debt servicing is stationary at level. In contrast, GDP, external debt, and exports are stationary at their first difference. For this reason, the ARDL model has been used to find the long-run and short-run interdependence among external debt, debt servicing, exports, and GDP. The empirical findings of this study revealed a negative and significant impact of external debt on Gross Domestic Product (GDP), supported by the “Debt Overhung Effect”. Conversely, debt servicing has a positive but statistically insignificant impact on GDP. Exports have a positive and significant impact on GDP growth. Moreover, to confirm the long-term stability of our model Cumulative Sum of Recursive Residual (CUSUM) and CUSUM of square have been used. This research contributes novel insights to the work conducted by other researchers, shedding light on the intricate relationship among external debt, debt servicing, exports, and GDP growth of Pakistan. Additionally, by estimating the effect of exports on GDP, valuable insights into the country's debt repayment capacity are provided. Export earnings constitute a primary source of foreign currency inflow.