External Debt and External Rate of Interest: An Empirical Analysis of Pakistan

Abstract

External debt is vital source of finance in developing countries and carries potential to play a key role in promoting economic growth. Traditional literature regarding economic growth has emphasised the positive role of debt in process of economic development. It inflows the process of growth by reducing the investment - saving gap, transferring the modern technology and increasing productivity. Pakistan lacks financial, human and physical capital, as well as macroeconomic stability. So, it has to depend on foreign assistance / foreign (Planning & Development Department, 2015). The effective policies of foreign debt are very important because it can have positive impact on growth of an economy if effective fiscal, monetary and trade policies are used. However, higher rates of interest charged by major International Development Partners i. e. World Bank (WB), Asian Development Bank (ADB), International Finance for Agriculture Development (IFAD), International Monetary Fund (IMF), Korean International Cooperation Agency (KOICA), and United Nations Development Program (UNDP) can reduce the propensity of provided assistance and eventually distort the development action. This paper evaluates the impact of interest rate on external debt in case of Pakistan using “Autoregressive Distributed Lag Model” (ARDL) approach. To study this relationship, time series data is used from the period of 1972 to 2013. To make this research applicable, External Debt (Ext-D), Interest Payment (Int-P), GDP, Budget Deficit (BD), Exchange Rate (ER) and Debt Services (DS) are taken as variable to evaluate the relationship. Here, " Interest Payment” data is used as a proxy variable for the actual rate of interest. This study investigates the linkages between External Debt and the interest rate for development projects in Pakistan. This paper also discusses how a government, combined with policies of donor agencies (particularly IMF) effects the development process especially w.r.t. interest rate and servicing etc.