Impact of Foreign Debt on Economic Growth in Ethiopia: The ARDL Approach to Co-Integration

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.