• Debt relief and growth

Debt relief and growth

Attempting to fill a gap in the literature, this paper examines the effect of foreign debt on growth with a particular focus on low income countries. It assesses empirically the effects of external debt on growth in low-income countries and analyses the channels through which these effects are transmitted, giving special attention to the indirect effects of external debt on growth through its impact on public investment.

Findings of the paper are:

• although high levels of debt can depress economic growth in low-income countries, external debt slows growth only after its face value reaches a threshold level estimated to be about 50 percent of GDP (or, in net present value terms, 20–25 percent of GDP)
• the substantial reduction in external debt projected for the countries participating in the HIPC Initiative would directly add 0.8–1.1 percent to their per capita GDP growth rates
• although the stock of public debt does not appear to depress public investment, the cost of servicing the debt does: the relationship is nonlinear, with the crowding-out effect intensifying as the ratio of debt service to GDP rises
• on average, every percentage point increase in debt service as a share of GDP reduces public investment by about 0.2 percentage point, implying that reducing debt service by about 6 percentage points of GDP would raise public investment by 0.75–1.0 percentage point of GDP, which, in turn, would result in a modest increase of about 0.2 percentage point in growth
• if a greater share of this debt relief— say, about half—could be channelled into public investment, growth could increase by 0.5 percentage point a year.

Based on these findings the paper suggests that:

• one way for country authorities to raise growth and combat poverty would be to allocate a substantial share of debt relief to public investment
• reducing the stock of debt alone—rather than immediately reducing debt service— is unlikely to induce governments to increase their spending on public investment
• although cutting debt-service obligations can provide countries with the breathing space they need to increase public investment, debt relief by itself is likely to raise public investment only modestly.

• Full text of document
• Publisher details
• Send to a friend