External Debt and Economic Growth: Does the Role of Governance Matter in Emerging Countries?

This study empirically investigates the impact of external debt on economic growth, and assesses whether institutional quality matters for this influence, using data from 18 emerging countries during 1996 to 2020. The findings indicate that although an upsurge in external debt negatively affects economic growth, this impact is mitigated when there is an improvement in institutional quality, as reflected by three governance indicators: anti-corruption perception, voice and accountability, and perceptions of the rule of law. However, other three governance indicators (political stability, government effectiveness, and regulatory quality) failed to affect the economic growth favorably. These results have important implications for policymakers in emerging countries who are currently facing major fiscal and external imbalances due to high expenditure on military goods/thigh cost of war, decrease in trade, and financial loss due to the COVID-19 pandemic. The study attempts to examine the relationship between external debt and economic growth by considering the importance of institutional quality in 18 emerging countries. It uses panel cointegration, panel ARDL, and Dumitrescu & Hurlin panel causality test causality test methods in the analysis. Results indicate that external debt negatively affect economic growth. But external debt combined with improvement in anti-corruption perception, voice and accountability, and the perceptions on the rule of law exert positive influence on economic growth. Therefore, emerging countries should focus on curbing corruption, giving freedom to citizens, and agents executing the standard roles of society.