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MACROECONOMIC EFFECTS OF EXTERNAL DEBT AND DEBT SERVICE ON ECONOMIC GROWTH IN PAKISTAN (A Case Study of Pakistan 1970-2010)
Waheed Murad (Corresponding Author) M.Phil Research Scholar Hamdard Institute of Education and Social Sciences (HIES) Hamdard University, Karachi, Pakistan Dr. Farooq Aziz Assistant Professor Department of Business Administration Federal Urdu University of Arts, Science and Technology Karachi, Pakistan Abstract
This study focuses the effects of external debt and debt service on Economic Growth of Pakistan considering the other explanatory variables such as gross capital formation, rate of inflation and terms of trade by using time series data for the period 1970 to 2010 is used. This study investigates the relationship between external debt, Debt Service and economic growth by using OLS regression model. Unit root test (ADF test) was used to check the stationarity of time series and after running OLS regression, test of normality, serial and auto correlation test, hetroscedasticity test, model specification tests were used. It was revealed through tests that regression line was best fitted; most of the independent variables were individually significant and were jointly significant to explain dependent variable that model was best specified and no error in the model was found. Results of estimation equation showed that external debt and debt service to GDP ratio have negative impact on economic growth of Pakistan as it was hypothesized and gross capital formation and inflation have positive impact on economic growth of Pakistan. The findings of the study is that practice of reliance on external borrowing is unsustainable unless serious efforts are made to overcome the basic weaknesses in the economy and to improve its overall productivity and to manage its debt in a better way. Key Words: Macroeconomic effects, External Debt, Debt Service, Economic Growth

1.

Introduction

In early seventies underdeveloped countries were encouraged by developed countries to borrow from abroad to finance their current account deficit to boost up their economic growth. From 1980s the international financial institutions have been providing help to debtor countries in an attempt to reduce their external debt burdens, foster growth, reduce poverty and attain viability. These measures have resulted in considerable success in alleviating the external debt burdens of many middle-incomecountries. However, many poor countries continue to suffer from poverty, civil conflicts, high external debt burdens and low economic growth. (Clements, Benedict, 2002) In the second half of the 1990s, policy makers and public opinion around the world have been increasingly concerned that high external indebtedness of developing countries is limiting growth and development. (Clements, Benedict, 2002).These debates made this issue very important and a lot of studies were conducted to

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understand the impact of external debts on growth and economic performance of developing countries. Like many other countries of the world, Pakistan has accumulated large external debt. Pakistan began to receive foreign economic assistance from July 1951 but substantial increase took place in outstanding debt during the second half of 1960s when debts were taken for building dams and industrialization. At that time the rate of accumulation averaged about 24 per cent per annum. At the end of December 1969, the external debt of Pakistan amounted to $2.7 billion while by December 1971, the figure rose to $ 3.6 billion and in June 1977 it was $ 7 billion which gives an average annual growth rate of about 11 per cent per annum. Later Pakistan continued to rely heavily on external resources to fill the increasingly high fiscal and external sector deficit and a sustainable pattern of external account was not maintained. One obvious consequence of continuous borrowing was the continuous debt-servicing burden. Thus a high level of debt stock and debt servicing emerged in the decade of 1980s and continued to be so in the decade of 1990s and afterwards in the second half of 2000s. Although the debt reduction strategy pursued in the beginning of the decade of 2000s brought some temporary relief in the form of restructuring and rescheduling of debt, yet in the financial year of 2007 alone, total debt and liabilities stock rose by 10 percent, the share of short-term debt increased and the share of foreign debt at floating interest rates also increased. This attempt has been made to study and analyze the causes of indebt-ness of Pakistan and to understand the relation of its external debt and debt service with economic growth in the presence of some other relevant variables. How and how far external borrowing has affected Pakistans growth performance is the fundamental question for this study.

2.

Data and Research Methodology

The level of this study is explanatory, seeking to identify the relation between the Economic

Growth and External Debt and Debt service. We used the Deductive Method and comprehensive analysis with literature review and econometric analysis. Econometric analysis served primarily to operations and regression analysis results, which were essential for hypothesis testing. The results of data analysis and estimation are obtained using statistical and econometrics computer packages (E Views version 3) The study is conducted based on secondary data collected from internal and external data resources. For this study the sample is the data set consists of 40 observations over the period 1970 till 2010 and in order to investigate the impact of external debt on economic growth of Pakistan econometric model and estimators are used. The data is analyzed using regression analysis. To avoid the spurious results that are associated with non stationary time series models Unit Root Test (ADF test) is used. To check the robustness and misspecification of the model, Normality Test, Serial and Autocorrelation Test (LM test), Hetroscedasticity Test (White Test), Wald-coefficient Restrictions

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Test and Redundant Variable likelihood Ratio Test are also used. Besides these tests descriptive statistics is also used. The data is obtained from domestic and foreign sources. For the domestic sources from Economic Surveys of Pakistan, Pakistan Economic Indicators, Federal Bureau of Statistics, State Bank of Pakistan while for external sources from World Debt Tables, Global Development Finance, World development Indicators, Different World Bank reports and IMF publications.

3.

Hypothesis

This study is preceded on the base of following hypothesis: that H0 HA High external debt and debt service has a negative correlation with Real GDP of Pakistan from 1970-2010 High external debt and debt service has a positive correlation with Real GDP of Pakistan from 1970-2010

4.

Empirical Literature Review

In economic literature of recent times, there are different studies about the relation between

External Debt and Economic growth. A few of these studies discussed that reasonable debt levels have a positive effect on growth; other models suggested that high accumulated debt stocks are likely to be associated with lower growth or negative growth. There have been several attempts to empirically assess the external debt-economic growth link i.e. debt overhang and crowding out effect theories. We discussed all these studies respectively: Amoateng and Amoako-Adu (1996) have investigated the relationship between external debt servicing, economic growth and exports for the total sample of 35 African countries during 19831990. The empirical results declared that there is a unidirectional and positive causal relationship between foreign debt service and GDP growth. Chowdhury (1994) investigated the direct, indirect and full effects of external debt on GNP and vice versa, by using a system of simultaneous equations. The results of the model show that the effect of public and private external debts on the GNP level is small. The author found that the external debt of developing countries is not a primary cause of economic slow down (Chowdhury, Khorshed, 1994). Fosu (1999) has employed an augmented production function to investigate the impact of external debt on economic growth in sub-Saharan Africa for the 1980 -1990 period. The author has used tests to measure the direct effect of debt overhang hypothesis namely that external debt negatively affect economic growth even if it has little or no effect on the level of investment. The findings show that as debt variable is included in the equation, debt exhibits a negative coefficient. And this might be due to a poor performer receiving large external debt ( Fosu, Agustin K, 1999). Krugman, Paul, stated that if there is some likelihood

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that in the future debt will be large than the country's repayment ability, expected debt-service costs will discourage further domestic and foreign investment (Krugman, Paul, 1988). Cunningham (1993) examined the association between debt burden and economic growth for 16 heavily indebted nations. This study concludes that the growth of a nations debt burden had negative effect on economic growth during the period of 1971-1979 (Cunningham, Rosemary, T., 1993). In economics, crowding out theoretically occurs when the government expands its borrowing to finance increased expenditure or tax reduction, crowding out private sector investment by way of higher interest rates. If increased borrowing leads to higher interest rates by creating a greater demand for funds and hence a higher "price", the private sector, which is sensitive to interest rates will likely reduce investment due to a lower rate of return. This is the investment that is crowded out and a fall in can hurt long-term economic growth (Gul, Adnan, 2008). Kruger(1987) states that after the rise in oil prices, the oil importing developing countries faced large current account deficits. On the other hand, oil exporters had large current account surpluses, which they lent to the commercial banks, which in turn financed the deficits of oil importing countries, thus the surpluses of the oil exporting countries were used by oil importing developing countries (Krueger, Anne O., 1987).

5.

External Debt and Economic Growth of Pakistan

Pakistans economy was agricultural based economy when it gained independence in 1947

from Britain. In sixties Pakistan was able to reduce the difference in growth of agriculture and manufacturing. Agriculture growth increased 6 percent while industry grew by 10 percent during the period 1960-65. (Zaidi, S, A., 2005) In1965 after war industrial growth was slow down, defense expenditure were increased while the GDP growth rate remained 6.8% on average per annum. The large deficit in the balance of trade throughout was financed by the increasing flow of foreign loans. In fact big foreign loans inflow helped accelerating the economic growth. At the end of December 1969, the external debt of Pakistan amounted to $2.7 billion while by December 1971, the figure rose to $ 3.6 billion. In 1972 government brought fundamental structural reforms and key industries, banks and companies were nationalized to break the link between the industrial and financial capital, improve the efficiency of the manufacturing sector and ensure a fair and equitable distribution of income, but the percentage share of both the manufacturing and agriculture in GDP declined. Growth rate in large scale manufacturing reached the lowest percent of 4.7 per annum. Thus decline in the two major sectors of the economy led to decline in GDP growth to 2.3 percent per annum even lower than the growth rate achieved in the period 1955-60. In 1977 external debt was $ 7 billion which gives an average annual growth rate of about 11 per cent per annum .Although the average growth rate has slackened since 1977-78, about 6.5 per cent per annum, the indebtedness continued to rise. In this era decisions to acquire debts and to increased budget deficit were influenced by political needs rather than economic priorities. Such uncontrolled expenditure mainly started during Zia era when foreign

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aid started to flow in due to Afghan war. (Zafar, Rehan, Muhammad., 2009) The large accumulated amount of foreign debt has increased the liability of debt service payments manifold. The total debt service payments (principal plus interest) which were only $182 million in 1970-71 rose to $603 million in 1980-81. Debt service went up to $ 788 million in 1984-85, $1.11 billion in 1987-88, $ 1.232 billion in 1989-90. Debt servicing liabilities grew at annual average rate of 8.3 per cent during 1980-81 to 1990-91. The debt servicing liability exhibits a rising trend in 1990s, rising from $ 1.316 billion in 1990-91, thus registering an average increase of 8.8 per cent per annum and showing an increase of 148 percent during the decade which means more than one billion dollar was accumulated each year. The period of 1980s was more focused towards denationalization and the role of public sector was to be reduced. The Growth rate of GDP in 1980s remained at 7.1% on average. The Pakistani economy in this era was benefited from rising worker remittances, which rose to a peak of US $3 billion in 1982-83 (10% of the GDP). The governments of 90s also brought in more debt and economic crisis for the country. These governments failed in reducing the fiscal gap, control, reduce borrowing or induce sustained growth in the economy. If we compare the decade of 80s with decade of 90s the later is more adverse. The external debt increased from $15.2 billion in 1989-90 to $28.6 billion in 1995-96 showing a growth rate of 11%. Debt servicing as percentage of GDP increased from an average of about 5% in 80s to nearly10% in the 90s. In 1986-87 debt servicing was 34.4% on total revenues of the government which increased to 51.7 percent in 1995-96 and the share of debt servicing in total expenditure was 23.5% in 1986-87 but then rose to nearly 40% in 1995-96, while its share in current expenditure rose from 31% to 46 %. External debt servicing as percentage of exports earnings increased from 32.6% in 1989-90 to 52.2% in 1995-96 and External debt servicing as percentage of total foreign exchange earnings increased from 18.8% in 1989-90 to 34% in 1995-96 (Appendix Table 6). For the year 1990-94, average GDP growth per year was recorded at 4.9 percent, which dropped further in the year1995-99 period to 4.3 percent. The slowdown in economic growth in this period occurred in the backdrop of a macroeconomic context that had been burdened by significant imbalances induced by fiscal imprudence of successive governments since the 1980s, and high fiscal and current account deficits, leading to unsustainable levels of public debt(domestic and external), an external financing constraint imposed by the Pressler Amendment, associated policy inconsistencies that were a result of an uneasy transition to democracy in the 1990s. As a result of these weaknesses Pakistan's investment climate deteriorated, leading to capital flight and a fairly systemic erosion of investor confidence over a period of time.(Asian Development Bank, 2002)

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Fig 1
60000 50000
3000

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Fig 2
4000

40000 30000 20000

1000 2000

10000 0 70 75 80 85 90 95 00 05 10 External Debt (million US $)

0 70 75 80 85 90 95 00 05 10 Total D ebt Serv ice (m illion U S $)

(Data Source: Economic Surveys of Pakistan, various issues, Bar Graph is plotted by using EView 3)

(Data Source: Economic Surveys of Pakistan, various issues, Line Graph is plotted by using EView 3)

In 2000, the government made significant inroads in macroeconomic reform, but more work was needed to be done. The event of September 11, 2001 and Pakistans alliance with coalition forces in the fight against terrorism helped its economy in many ways. The rescheduling of $12.5billion bilateral and multilateral external debts resulted in about $1.5 billion annual relief in shape of decreased debt servicing charges. Lifting of sanctions brought handsome foreign grants about $1 billion to $1.5 billion per annum during last four five years. Some external debts were written off. U.S. assistance has played a key role in moving Pakistan's economy from the brink of collapse to setting record high levels of foreign reserves and exports, historic low inflation, solid 5% GDP growth, and dramatically lowers levels of debt in 2002. The GDP growth rate remained around annual average of 4.9% during 2000s. The Fiscal deficit remained around annual average of 4.5% of GDP while the primary balances remained surplus. The current account balance remained surplus around an annual average of 1.9% of the GDP. The external debt increased to $37 billion in 2005 that is 36.6% of the GDP as compared to 50.2% of GDP in 2000. In fact public Debt to GDP ratio declined from 102.8% of the GDP in 2000 to 74.6.3% of the GDP in 2005 mainly because of healthy GDP growth rate and premature retirement of expensive debts to ADB. (Appendix , Table6).
Pakistan positioned itself as one of the four fastest growing economies in the Asian region during 2000-07 .Its real GDP increased from $60 billion to $170 billion, with per capita income rising from under $500 to over $1000 during 2000-07. Large capital inflows financed the current account deficit and contributed to an increase in gross official reserves to $14.3 billion at end-June 2007. On October

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11, 2008 State Bank of Pakistan reported that country's foreign exchange reserves had gone down by $571.9 Million to $7749.7 Million. The foreign exchange reserves had declined more by $10 billion to an alarming rate of $6.59 billion. In November 2008, The International Monetary Fund (IMF) has approved a loan of 7.6 Billion to Pakistan, to help Stabilize and rebuild the country's economy. More recently the government of Pakistan received an economic aid of US $5bn dollars out of which the US pledge of $1bn was described as a down-payment on the previously announced $1.5bn already promised to Pakistan for each of the next five years. The European Union promised $640m over four years, while reports said Saudi Arabia had pledged $700m over two years. Overall Friends of Pakistan had pledged $1.6 billion in aid, which would help Pakistan, move forward on its way to self-reliance. Despite, the severe challenges, the economy has shown resilience in the year 2009. GDP growth for 2009-10 has been recorded at 4.1 percent while it was 1.2 percent in 2008-9. The incipient recovery in the economy has come about in the face of strong headwinds. The severe challenges the economy had to navigate through in the outgoing year were energy and water shortage and the sharp rise in the number of incidents of terrorism across the country and the scale and nature of attacks, which affected growth and investment. The global "war on terror" has been imposing a heavy cost on the economy since 2001. It is estimated that the cost to the economy of terrorism amounted to around 6 percent of GDP in 2009-10 and Pakistan has impacted to the extent of over US$ 43 billion between 2001 and 2010 (Economic Survey of Pakistan 2009-10). The economic history of Pakistan reflects the Fig 3 Governments current inability to forced establish cuts a
10 8 6 4 2

sustainable pattern of public finance. High expenditures in development expenditures thus retarding the infrastructural development. An inelastic, nonprogressive tax structure with narrow tax base and a big size ever developing black economy are the main structural weaknesses in the fiscal policy. The easiest recourse of monetizing the budget deficit and financing the expenditures by borrowing from abroad was adopted. The result was an ever-rising public debt and expenses on debt servicing. The policy makers always been attracted

0 70 75 80 85 90 95 00 05 10 GDP Growth (annual percent)

(Data Source: Economic Surveys of Pakistan, various issues, Line Graph is plotted by using EView 3)

by the idea of maximizing foreign assistance for financing budget deficit and big investment lay out to achieve high growth. The domestic savings were too low to finance it. Instead of relying upon stable

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and sustainable sources of external financing like exports, FDI, portfolio investments and foreign assets of Pakistan for stimulating growth of economy, the policy makers remained dependent on unstable and less sustainable sources of external financing like loans, foreign aid, and remittances. Thus the economy of Pakistan has always remained under stress due to high fiscal and external sector imbalances, high aggregate demand, unsustainable GDP growth, high unemployment and levels (Mehmood, Tahir., 2008). poverty

6.

Model Specification
Recent literature has provided a significant body of evidence about the most relevant

indicators and predictors of external debt crises. The key macroeconomic indicators are output growth, external debt ratio to GDP, external debt service ratio to GDP, external debt service ratio to exports(reflects the crowding out effect), gross capital formation , rate of inflation(reflects macroeconomic stability) and terms of trade (captures external shocks). To capture all relevant debt burden indicators, the model adopted is based on Elbadawi et al's (1996) model specification. Like in similar studies, the debt burden indicators enter the production function directly, therefore, the regression equation is specified as: RGDPt = f (ED, TDS, DSR, GCF, INFL, TOT)----------------------------------(1) Where RGDPt = Real GDP at time t, ED = Stock of External Debt to GDP ratio (-), TDS = Total

Debt Service to GDP ratio (-), INFL = Rate of Inflation (- or +), DSR = The Debt Service as a ratio of export earnings (-), TOT = Terms of Trade (- or +), GCF = Gross Capital Formation as a ratio of GDP (+) Using equation (1) and expressing the variables in natural logarithmic form, an attempt has made to look at the relative contributions (elasticitys) of each variable to the growth process. Therefore, the model to be estimated is specified as: LRGDPt = 0 + 1LED+ 2LTDS+ 3LDSR+ 4LGCF+ 5LINFL + 5LTOT +t---------- (2) In equation (2) above, all variables are in log form and 1, 2, 3, 4 elasticitys, and t is the random disturbance term.
and

5 are coefficients of

7.

Econometrics Results
We used Augmented Dickey Fuller (ADF) tests to test the stationarity of the series. We

applied this test on four stages; at first without trend and intercept, then with trend but without

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intercept, then with trend and intercept and we found that all variables were non stationary therefore at last stage we test all series with 1st difference and ADF statistic(t statistic) was less than ADF critical values (1%,5%,10%) and in all cases p value was less than 0.05 so null hypothesis that unit root exists was rejected which means the 1st difference of variables become stationarity. Then we transformed all series with 1st difference (See Results in Appendix Table 1). After transforming all variables in 1st difference we run the Ordinary Least Square (OLS) Regression equation. In the results R-squared is 0.79. It means that 79 percent variation in RGDP can be explained jointly by six independent variables such as LTDS, LDSR, LED, LGCF, LINFL and LTOT. The rest 21 percent variation in RGDP can be explained by residuals or other variables other than mentioned below. Most of the independent variables are individually significant to explain dependent variable. This matter was checked by t statistics and its p values. In our case as shown in the OLS output results p value for LTDS is 0.00, p value for LDSR is 0.01 and p value for LED, LGCF, LINFL is 0.00 and p value for LTOT is 0.68. Since the p value for first five variables is less than 0.05 we can reject the null hypothesis that coefficients are equal to zero, and can accept alternative hypothesis but for LTOT p value is more than 0.05 so we cannot reject null for this variable. Hence we can conclude that independent variables LDSR, LED, LGCF and LINFL are significant and can influence RGDP but the independent variable LTOT is not significant at 0.05 level of p value to explain RGDP (See results in Appendix Table 2) Independent variables are jointly significant to explain dependent variable. This matter was checked using F statistics. Null hypothesis Ho : B1=B2=B3=B4=B5=B6=0, Alternative H1: Not all Bs are simultaneously equal to zero. If the p-value of F statistic is less than 5 percent (0.05) we can reject the null and accept alternative hypothesis. If we can reject null hypothesis, it means that all the independent variables jointly can influence dependent variable. In this case as shown in the OLS results F statistics for joint hypothesis is 20.39 and p value is 0.00 so we can reject the null hypothesis and can accept alternative hypothesis. It means that all the independent variables jointly explain dependent variable. We plotted the histogram of residuals the applied jarque-Bera statistics to check the normal distribution of residuals and the null hypothesis was that residuals are normal distributed results show that jarque Bera statistics (0.617478) and p value is 0.73 which is greater than 0.5 (See Appendix Fig4)thats why we cannot reject null hypothesis and we accepted that residuals are normal distributed.

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7.1 Serial or Autocorrelation and Model Specification Tests Results

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Serial correlation can be formed in the model because of incorrect model specification, incorrect functional form, and incorrectly transformed data or because of incorrect model specification. For this purpose Breusch-Godfrey Serial Correlation LM test was applied and its results showed that F statistics is 0.37 and p value 0.69 and Observed R-squared is 0.94 and p value is 0.63. Since p values are more than 5 percent (p>0.05), we can not reject null hypothesis meaning that residuals (u) are not serially correlated which is desirable (See Appendix, Table 3). We also plotted correlograms of residuels which shows that Q statistics is insignificant with large p values which means that there is no serial correlation in residuals, and no autocorrelations and partial autocorrelations at all. Then we applied White Heteroscedasticity test. Heteroscedasticity is a term used to describe the situation when the variance of the residuals from a model is not constant and it is not desireable. When the variance of the residuals is constant, we call it homoscedasticity which is desirable. In this test Null Hypothesis was that Residuals (u) are Homoscedastic and Alternative hypothesis that Residuals (u) are Hetroscedastic. White heteroskedasticity tests results show that the p-value of Observed R-squared is more than 0.05 which show that we can not reject null. So residuals do have constant variance which is desirable meaning that residuals are homoscedastic (See Appendix, Table4). Given that the model is well-specified (to be argued in our case) as in OLS Regression Results t statistic of variable TOT is 0.42 and p value is 0.68 which is more than 0.05 and we cannot reject null hypothesis (H0 : B6=0)which means this variable TOT has no significance in this model so we can drop this variable. For this purose we applied Wald-coefficient Restrictions Test. In Wald Test Ho : B7=0 and result showed that p values of F statistics and Chi-square both are more than 0.05 so we cannot reject null hypothesis, which means the coefficient of variable TOT is 0 and it has no significance in the model. So we dropped this variable from the model because it is tested that it has no significance in this model and our estimation equation was as under (see Appendix, Table5) DLRGDP = 0.07293461184 0.2080456134*DLTDS + 0.2136987951*DLDSR -

0.3885645645*DLED + 0.4339552472*DLGCF + 0.0562451565*DLINFL This estimation equation shows that Debt Service to GDP ratio and External Debt to GDP ratio affect RGDP negatively whereas, Debt Service to exports ratio, Gross Capital Formation and Rate of Inflation have a positive effect on output. The individual coefficients represent respectively, elasticities with respect to output.

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8. Conclusion

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This study attempts to evaluate how external debt is possibly hitting economic growth in Pakistan. The study tries to explore the linkage between economic growth and external debt by using the set of major macroeconomic and external debt indicators. A number of equations are estimated, however, we report only that equation which include the variables found consistently significant. The results of the various diagnostic tests are reported and the tests did not detect any problem of hetroscedasticity, non-normality and serial or autocorrelation. None of these tests reported were nothing to suggest that the model was mis-specified. The goodness of fit, also called the overall significance of the model, as measured by R squared, shows that about 79.27 percent of the variations in the dependent variable (LRGDP) is explained by the explanatory variables. This overall significance test of the model indicated that explanatory variables jointly are statistically significant. The results of estimated equations showed that the coefficients of most of the independent variables have expected signs and are statistically significant, except for TOT variable. The sign of the coefficient of TOT variable is positive and it is not statically significant thats why it is dropped from the model. The results suggest a negative impact of stock of external debt to GDP ratio on the output (Real GDP) and it was expected and aligned with the theory. The results tally with the findings of similar studies. And this result confirms that an excessively high stock of external debt affects economic growth negatively, and as it is statistically significant, hence the main hypothesis that debt to GDP ratio has negative impact on economic growth is not rejected. The results also suggest a negative impact of Debt Service to GDP ratio on output which was expected. These findings support the hypothesis that debt service, which requires the use of foreign exchange earnings in repaying loans to creditors, divert resources from productive domestic investment and consequently, hinders economic growth. However, the impact of debt service to export ratio on economic growth is positive and statistically significant. The impact of Gross Capital Formation to GDP ratio is positive and statistically significant; supporting the findings of the earlier studies that capital formation is the main source of economic growth. Furthermore, the coefficient is quite robust in the estimated equation. Further, focusing on the perspective of mobilization of private investment in developing countries, our model suggests that higher GDP growth rate attracts private investment and helps in mobilizing resources towards investment. However, external debt stock to GDP and Debt servicing to GDP does hamper economic

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crowding out.

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growth, and may leave less funds available to finance private investment in the country leading to

The estimates for inflation are significant but the degree of effect is relatively lower. It has been said that inflation may stimulate growth at low and containable levels but can impact negatively on growth at high levels. The results show that current inflation rate stimulates economic growth.

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References
Amoateng, Kofi. Ve Amoako, Adu.B.(1996): "Economic Growth, Export and External Debt causality: The case of African Countries." Applied Economics, Vol 28, pp 21-27

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Asian Development Bank (December 2002) Escaping the Debt Trap; An assessment of Pakistan's External Debt sustainability, working Paper no.1 pp 4-5 Chowdhury, Khorshed(1994): " A Structural Analysis of External Debt and Economic Growth: Some Evidence From Selected Countries in Asia and Pacific", Applied Economics, Vol 26, pp1121-1131) Clements, B., Bhattacharya, R., and Nguyen, Q., (2003), External Debt, Public Investment, and Growth in Low-Income Countries. IMF Working Paper 249. Cunningham, Rosemary, T. (1993): " The Effects of Debt Burden on Economic Growth in Heavily Indebted Nations", Journal of Economic Development Economics, Vol 52, pp 169-187) Economic Survey of Pakistan 2004-5, 2006-7, 2007-8, 2008-9, 2009-10 An online publication by accountancy.com.pk Elbadawi, A. I., J. B. Ndulu., and N. Ndungu (1996), Debt overhang and economic growth in SubSaharan Africa, A paper presented to the IMF/World Bank conference on External Financing for Low Income Countries in December Fosu, Agustin K (1999) " The External Debt Burden and Economic Growth in the 1980s: Evidence from Sub-Sahara Africa", Canadian Journal of Development Studies, Vol 20, No 2, pp 307-318 Gul, Adnan (2008) Pakistan's Public Debt: The shocks and aftershocks, http://mpra.ub.unimuenchen.de/11427) Krugman, Paul, 1988, " Financing Vs. Forgiving a Debt Overhang," Journal of Development Economics, Vol. 29, pp 253-268) Krueger, Anne O. (1987): "Debt Capital Flows, and LDC Growth, American Economic Review, Vol 77, pp 159-164) Mehmood, Tahir., Rehman, Hafeez-ur., (2008) Evaluation of Macro Economic Policies of Pakistan(19502008), Journal of Political Studies, pp 60-61) Pattillo, C., Poirson, H., and Ricci, L., (2002), External Debt and Growth, IMF Working Paper 69. WP/2002/69. ).

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State Bank of Pakistan Annual Report 2008-2009(October 30 2009)

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World Bank. World Debt Tables/Global Development Finance/World development Indicators (various years). Washington, D.C. The World Bank Zaidi, S, A., (2005) Issues in Pakistan's Economy, pp 2) Zafar, Rehan, Muhammad., 2009 The Debt Trap: IMF, the World Bank and Pakistan,

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Appendix
Table 1: ADF test Results(E View3 out put):
LRGDP ADF with 1st difference ADF Test statistic 1% critical value 5% critical value 10% critical value LTDS LDSR LED LGCF LINFL LTOT

-5.21052 -4.2092 -3.5279 -3.1949

-8.90956 -4.2092 -3.5279 -3.1949

-8.07327 -4.2092 -3.5279 -3.1949

-8.17143 -4.2092 -3.5279 -3.1949

-4.24217 -4.2165 -3.5312 -3.1968

-6.79357 -4.2092 -3.5279 -3.1949

-6.61211 -4.2092 -3.5279 -3.1949

Fig 4 : Normality Test (Histogram and Jarque-Bera Statistic)Result

14 12 10 8 6 4 2 0 -0.10

Series: Residuals Sample 1971 2009 Observations 39 Mean Median Maximum Minimum Std. Dev. Skewness Kurtosis Jarque-Bera Probability 9.99E-17 0.005248 0.108182 -0.099329 0.053354 0.194876 2.522423 0.617478 0.734372

-0.05

0.00

0.05

0.10

Table 2: OLS Regression Result (E View3 out put):

Dependent Variable: DLRGDP, Method: Least Squares Variable Coefficient Std. Error t-Statistic C DLTDS DLDSR DLED DLGCF DLINFL DLTOT R-squared Adjusted R-squared S.E. of regression Sum squared resid Log likelihood Durbin-Watson stat 0.073160 -0.210158 0.214033 -0.393300 0.447286 0.057763 0.031321 0.792689 0.753818 0.058142 0.108174 59.46913 1.828697 0.009699 0.079846 0.073280 0.076052 0.148980 0.017022 0.074603 7.543000 -2.632026 2.920755 -5.171493 3.002315 3.393504 0.419834 Prob. 0.0000 0.0130 0.0064 0.0000 0.0052 0.0019 0.6774 0.071389 0.117181 -2.690725 -2.392137 20.39289 0.000000

Mean dependent var S.D. dependent var Akaike info criterion Schwarz criterion F-statistic Prob(F-statistic)

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Table 3: Breusch-Godfrey Serial Correlation LM Test (E View3 out put):
Breusch-Godfrey Serial Correlation LM Test: F-statistic Obs*R-squared 0.369992 0.938822 Probability 0.693848 Probability 0.625371

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Table 4: Hetroscedaticity test (E View3 out put)

White Heteroskedasticity Test: F-statistic Obs*R-squared 1.430272 15.50780 Probability Probability 0.214680 0.214833

Table 5: Wald Test (E View3 out put)

Wald Test: Equation: Untitled Null Hypothesis: C(7)=0 F-statistic Chi-square 0.176260 0.176260 Probability Probability 0.677412 0.674607

Table 6: Data series used in OLS Regression analysis (1970-2010)

Year RGDP (Real GDP) ED (External Debt Ratio of GDP 34 34.4 30.8 71.9 55.2 48.4 47.7 47.5 44.6 43.8 39.8 36.5 34.3 41.5 40.3 40.7 44.1 47.7 44.2 42.2 48.7 46.8 TDS (Total Debt Service ratio of GDP 1.8 1.7 1.3 3 2.2 2.2 1.9 2.1 1.8 2.2 2.5 2.1 1.6 2.2 2.3 2.5 2.8 3.3 2.9 2.8 3.1 2.9 DSR (Debt Service ratio of Export receipts 52 43 21 24 19 24 22 27 25 26 25 20 20 24 26 32 30 30 25 24 25 22 TOT (Terms of Trade) 87 90 83 96 106 67 71 109 105 126 111 97 89 89 95 93 90 96 96 90 90 78

1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991

10027 10602 9309 6325 8773 11340 13338 15126 17820 19708 23690 28101 30726 28692 31152 31145 31899 33352 38473 40171 40010 45451

GCF (Gross Capital Formation ratio of GDP 16 16 14 13 13 16 17 19 18 18 18 19 19 19 18 18 19 19 18 19 19 19

INFL (Rate of Inflation GDP deflator, annual %) 4 5 6 16 25 24 12 9 9 7 9 10 9 5 10 5 3 5 10 9 6 13

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1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 48635 51478 51894 60636 63320 62433 62191 62973 73952 72309 72306 83244 97994 109502 127325 142893 164500 162300 173600 49.9 49.5 50.1 50 50.6 50.2 49.3 50.2 57.5 51.1 54.9 51 44.7 37.3 33.5 32.2 27 31.2 30.3 3.1 3.2 3.4 3.4 3.4 3.6 3.8 2.6 2.1 2.8 1.6 1.6 3 1.3 1.2 1.1 1.2 2.1 1.7 22 24 26 25 25 27 27 20 18 21 13 12 24 10 10 9 10.3 18 15.7 20 21 20 19 19 18 18 16 17 17 17 17 17 19 22 23 22 19 10 9 13 14 8 13 8 6 25 8 2 4 8 7 10 8 16 20 10

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83 81 101 103 100 102 124 116 98 91 91 82 79 74 65 63 55 57 56

Source: World Development Indicators (WDI) & Global Development Finance (GDF) http://databank.worldbank.org/ddp/home.do and Economic Surveys of Pakistan (several issues)

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