Abstract:
As a result of low domestic financial resource base, Ethiopa is one of the poor countries that
makes it to rely heavily on foreign debt to finance its development endavours.This phenomenon
attracted researchers and policy makers to examine the relationship between the two
maceoeconomic variables.The main objective of this study was to analyze the relationship
between economic growth and foreign debt in Ethiopia. In light of this major objective, the
paper also posed and tried to answer one major question: is there any foreign debt level that
keeps economic growth at its maximum point? To that end, the researcher used secondary data
from world Bank and the study employed ARDL model from 1981/82 to 2021/22 using GDP per
capita as dependent variable and percentage of foreign debt to GDP, human capital , physical
capital , population growt rate,and international trade as explanatory variables.The ARDL
result assured that in the long-run foreign debt,population growth rate and international trade
have a significant negative effect on economic growth. But physical capital measured by fixed
capital formation was found to have a significant positive impact on output growth.Human
capital have retained its expected positive sign but it is statistically not different from zero.
Besides the short run error correction term is -0.489 which implies that about 48.9 percent
annual short run deviations adjusted towards long run equilibrium position. In the second step
by taking into account threshold effect of foreign debt on economic growth, the study estimated
the threshold value of foreign debt that is optimal for sustained economic growth for Ethiopia by
applying threshold regression. The threshold Estimation result pinpointed that around 51.98894
percent of foreign debt to GDP is ideal foreign debt level for the smooth economic growth.
Furthermore most of the variables retained their level of significance as well as expected sign at
the optimal level of foreign debt.Therefore in view of these results this study recommended the
government of Ethiopia improve the existing policies on foreign debt management to be arround
the estimated optimal level.
