International Journal of Advanced Research and Publications

ISSN: 2456-9992

The Impact Of Public External Debt On Economic

Growth Of Ethiopoia
Mohammed Endris Awol

Ethio shop supervisor in ethio telecom,

Ethiopia, PH-+251-920 06 0000
muha.fet@email.com
Abstract: This study attempted to assess the impact of public external debt stock on economic growth of Ethiopia over the year from 1971
to 2018. Particularly, the study sought to answer weather public external debt stock and debt servicing has any significant impact on real
GDP, the trends of public external debt stock and external debt repayment and this study also investigated the directional relationship
between public external debt and real GDP of the country. The data used for this study was gathered from World Bank, world development
indicator, international monetary fund, national bank of Ethiopia, ministry of finance and economic development and united nation
conference for trade and development. The study was conducted by using Eviews 11 statistical software and employed Auto regressive
distributed lag (ARDL) approach to real GDP data as a function of stock of public external debt, public external debt servicing, fixed capital
formation, inflation rate, export, real effective exchange rate and trade openness. The empirical finding result from the study revealed that
public external debt stock has an adverse significant impact to economic growth of Ethiopia both in the long run and short run with a
coefficient of 0.133 and 0.050 respectively, which possess a greater challenge for the growth of a country. While public external debt
servicing has positive significant impact to real GDP both in short run and long run with a positive coefficient of 0.0433 and 0.1356
respectively. On the other hand, the variable fixed capital formation, inflation rate, export and real effective exchange rate has positive
significant impact to economic growth of Ethiopia. Thus, the study recommended that the government should minimize the reliance on
external debt by diversifying the sources of finance through mobilizing its own resource domestically and enhance the exports of country
and reduce imports of luxuries goods and also they should conduct those measures which minimize fiscal deficit so as to tackling the
problem of severe external debt burden. The government should place an embargo on further acquisition of public external finance, except
for top priority projects public external debt should use wisely and effectively in attention with the country’s short-run and long run
macroeconomic conditions.

Keywords: Public External debt stock, Public External debt servicing, Economic Growth

1. Introduction relationship with GDP growth, the debt burden of a country

Sustainable economic growth is the dominant concern of all and the consequent debt service impose a constraint on the
economies, especially for developing nation’s economy that economy. This is due to insufficient foreign exchange to
commonly face fiscal deficit mainly driven by inelastic finance imports of raw materials and capital goods needed
current expenditure. Even though, LDCs strive for higher for economic growth in the long run as well the debt stock
economic growth trajectory, but given higher fiscal may act as a tax on future income and production and may
imbalances, they find it difficult to generate investment that discourage investment by the private sector in the future [3].
can help to economic progress. Therefore, these economies
become depend up on a huge foreign borrowing that leads to 2. Statement of the problem
substantial public external debt accumulation over time [1]. A country is seen as in a high risk of debt distress when it
The occurrence of deficit in Sub Saharan Africa countries in struggling to service its debt. Even though borrowing is
the post global financial crises period leads to weaken usually seen as the prerequisite for economic growth,
currencies value, rising the borrowing cost, along with unsustainable external debt results a significant risk on
imbalance growth perspective are creating perverse global commitments to eradicate poverty and sustainable
dynamics of public external debt accumulation that might development. Unstable public external debt burden forced
jeopardize public debt sustainability. Larger fiscal deficit is the government to spend more on debt servicing and less in
contributing for a current rising public debt level in the health services, education and infrastructure. High debt
region, among other factors. From the year 2013, the burden also creates uncertainty, retarding investment and
dynamics and composition of public debt changed in innovation [4]. Ethiopia was under a serious external debt
significant manner. Public debt raised on average from 37% problem until 1990 as shown by the qualitative and
of GDP in 2013 to 56% of GDP in the year 2016. Debt quantitative analysis. This was affected her good name and
sustainability risk in the nations of this region increase over access from external concessional borrowing window were
the past few years, with 18 countries at high risk of debt totally closed. There was debt overhanging, crowding out
distress as March of 2018 compared with 8 countries in 2013 and liquidity problem born out fragile state followed by
[2]. Debt service on the other hand, showed a negative Dergue regime that was characterized by large borrowing
impact with the economic growth of a country. The more the from multilateral, bi lateral and commercial creditors to
external debt payments, the lesser will be funds rose for finance war and unstable macroeconomic policy (Teklu et al.
public services such as the construction of roads, hospitals, 2014). As 2017 debt sustainability assessment, debt service
schools and new business opportunities in the long run. It is to export ratio shows a breach, which is more persistent and
not surprising to face this result since external debt servicing larger than the year 2016. The ratio exceeds the threshold in
requires the outflow of financial resources in terms of 2018/19 and reaches the peak point in the future [5]. In fact,
foreign currencies which is already extremely less in supply. there have been attempts by the previous researchers on the
Even though, the debt stock has a significant strong positive same topic in Ethiopia. However, most of the studies

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 International Journal of Advanced Research and Publications
ISSN: 2456-9992

conducted in Ethiopia have the following limitations. First, tax burden made increasingly onerous due to the need to
they did not separate total external debt in to private and service the public debt. Ricardo therefore recommended that
public external debt, in a real case splitting external debt is public debt redeemed in order to deter capital flight. With the
crucial since their transmission channel are different in concern of capital accumulation Ricardo justified tax
saddling an impact on economic growth. Second financing of government expenditure in preference to public
methodological limitation observed in the thesis conducted loans. Public borrowing harmed capital by misleading the
by Hana [6] on the impact of external debt on economic population as to the extent of government wastefully and as
growth of Ethiopia independently by using simple ordinary to the extent of their own personal wealth. As per Ricardo’s
least square (OLS) for method of analysis in which the result view, tax and loan are source of financing to government
may not valid or spurious even if it showed significant expenditure, but they were not equivalent in a practical
impact. Third most of the previous researcher uses co context, the choice of which of them to employ would have
integration method of analysis. Even though this technique is various implications for the level of investment and thus the
widely used for time series data, its result is unreliable for growth rate of capital. If a taxpayer did not properly
small sample size [7]. The other limitations of this model are calculate the future tax burden implied by public borrowing,
related with the use of Johnson procedure of co integration he will not recognize the necessity to invest at the time the
analysis that has a high probability of generating outliers, as borrowing takes place in order to ensure a future return to
well as high variance [8]. meet his future tax liability. Therefore, the level of
investment is lower than it would be needed to pay the tax.
3. Literature Review Generally, Ricardo made two related policy implication.
First, with the absence any means of source of finance the
3.1 Theoretical Literature government expenditure must be filled by source of
According to World Bank, external debt can be defined as borrowing. Second, sound and effective action should be
“the sum of obligation arising from the agreement and undertaken immediately to redeem existing public debt [12].
requirement to repay the principal with or without interest, or Ricardian equivalence theory is that the level of government
the interest with or without capital for the debts which should external debt is not as such important and does not have any
be repaid by residents in a country to non-residents in a impact on the economy. This theory states that public debt
country, which they have borrowed and have not repaid yet did not influence consumption level, capital including the
[9].” External debt defined as a transfer flows which are growth of an economy; if government decrease taxes now,
generally obtained from the external sources of finance. This society should know that taxes would be raise in the future.
results an increasing effect on the national income of a nation Therefore, the people would not consume more but they
during the time of borrowing and a decreasing effect during would be saved more in order to pay the future tax rate and
the time of servicing the debt. It is financing resources which the budget deficit will coincide with an increase in private
are mostly used by developing countries than the advanced saving. Things became different in the long run, if this theory
countries. They are applied in facilitating growth and does not hold, the reduction of public savings brought about
development of nation’s economy. Particularly developing by a huge budget deficit will not be fully compensated by an
nation borrow due to lack of national resource, high level of increase in private savings. As a result, total national savings
deficit, lack of saving and deficit in balance of payment [10]. will decline, resulting in lower total investment, either
domestic or foreign. Lower investment at home will have a
3.1.1 Keynesian Theory of Public debt negative effect on the growth of an economy since it will
An economic crisis created by the great depression of 1930 lead to a smaller capital formation, higher interest rate, lower
was partly laid an impact for the development modern theory labor productivity and wages. Lower foreign direct
of public debt. As per Keynes postulate, there were investment or higher capital flight instead, will leads to a
unemployed resources which the private sector could not negative significant impact on foreign capital income and
use, these resources can be used to balance budget. will thus lower the country’s future GNP. This negative
According to his view an increase in public debt through a impact of an increase in public debt on future economic
multiple impact would raise the national income. He linked growth or GNP can be revealed by the presence of distortion
the public debt with deficit financing and an authorized in the taxes [13].
government can borrow to boost the economy output by 3.1.3 The conventional view
increasing demand and employment level. According to Elmendorf & Mankiw, have published the working paper
Precious, argued that a rise on the government debt is a named Government Debt, in this paper they have analyzed
burden on the country’s economy. In addition, an about the conventional view. They describe it as the
expansionary fiscal shock is due to increasing government approach agreed by the majority of economists and
spending, this increment in government spending results on policymakers. The analysis of this view is depending on the
the contraction of public debt, if the collected revenue fails assumption that tax reduction is equal with the increase in
to meet the expenditure. At the end this scenario raises the debt. In the short run, economists agree that lower taxes
country’s demand of goods and services, since more money result the increase in households’ disposable income as well
in the economy is prevail [11]. as consumption. As per Keynesian theory, the higher
aggregate demand increases national income. Keeping both
3.1.2 Ricardian theory of Public debt prices and wages constant, higher demand affects the
David Ricardo assessed the impacts of the tax burden production of a nation. Therefore, government will raise
resulting from public debt. Ricardo also examined the deficit by the tax cut or increasing government spending. To
problem of public debt from the perspective of its impact on sum up, fiscal policy can affect the national income of a
capital stock and its rate of growth. He shared the country merely by changing the supply of factors of
widespread anxiety in which capital might drive abroad by a production [13].

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3.2 Empirical Literature review positive impact in the long run, but debt servicing has
3.2.1 Cross country studies negative and insignificant impact on economic growth. The
Naeem Akram, had done a research on the nexus between Granger causality test revealed that there exists
public debt and economic growth of Asian countries by unidirectional causation between GDP and external debt
using generalized moment method (GMM) analysis. In doing stock [20]. A similar investigation was done by Ajayi, on
so, external debt as percentage of GDP and debt servicing as the effect of external debt on Nigerian economy. The study
a percentage of GDP has a negative significant impact on the was adopted OLS techniques and the result stated that
growth of Asian economy [14]. external debt lay down an adverse effect on nation’s income
Abu Siddique, investigated the impact of external debt on and per capita income of the country. External debt servicing
economic growth of 40 highly indebted poor countries by and interest rate has also positive significant impact on
using panel data over the period of 1970 to 2007 and apply economic growth of the nation [21]. Aderoju, also had done
Autoregressive distributed lag method of data analysis. The a study on the relationship between external debt, debt
study showed that the variable external debt has a negative servicing and internal debt in case of Nigerian economic
significant impact on economic growth both in the long run service provision. The researcher adopted OLS method to
and the short run in the three sets of alternatives pooled analyze the collected data. The empirical finding revealed
estimates; namely, the mean group (MG), the pooled mean that external debt and debt servicing had an adverse
group (PMG) and the dynamic fixed effect estimation. This relationship with economic service provisioning or spending
implies, having higher level of debt as a proportion of GDP by the government. On the other hand, internal debt had
would have decreased the level of GDP in HIPCs [15]. inversely related to economic service spending [22]. A study
Amilkar, tried to analyze empirically the impact of external by Kumar, also examined the macroeconomic impact of
debt on economic growth across the varying level of public stock of public debt in India using a Structural Vector Auto
debt to GDP ratio for 20 advanced countries over the period regression (SVAR) technique for the period from 1980 to
from 1946 to 2009. The study employed OLS method of data 2017. The variable used on this study was public debt,
analysis and from the regression analysis public debt has economic growth, investment, interest rate and inflation in
adverse significant impact on economic growth of advanced India. The results confirmed that public debt has an adverse
economy [16]. effect on economic growth, a positive impact on long-term
interest rate and a mixed response on investment and
3.2.2 Single country studies inflation in India. It is also stated that the domestic debt stock
Abula and Ben-Daddy, investigated the impact of public had adverse effect on Indian economy than external debt.
debt stock on Nigerian economy by using over the time The finding from variance decomposition analysis revealed
spanning from 1986 to 2014. The study applied the Johansen that much of the variations among selected macro variables
co-integration test, Error Correction Method (ECM) and the are explained by public debt and growth in India [23].
Granger Causality test. Co-integration results declared that
the existence of a long-run relationship between the Empirical study in Ethiopia
variables; external debt, domestic debt, external debt Dagnachew, had tried to explore the extent and to assess
servicing, domestic debt servicing and economic critically and ascertained the causality linkage of public
development in Nigeria. Out come from ECM revealed that external debt that retard the ongoing GDP growth and
stock of external debt and servicing of it have negative development of Ethiopia. The Researcher used annual time
insignificant relationship with Nigerian economy [17]. An series data spanning from 1970 to 2016. The researcher
empirical finding by David and Etido, assessed the impact of applied co integration method and Granger causality
external debt on growth of Nigera. The study employed OLS approaches to analyze the collected data. The finding of the
and co integration and ECM model for the period from 1980 analysis declared that, the economic growth equation shows
to 2012. The result from ECM model showed that the that external debt stock was found not insignificantly effect
coefficient of external debt flow was leads to a reduction on to economic growth in Ethiopia. In addition, the granger
economic growth. That means the current debt flow deter the causality approach also indicated that there is no
growth of the economy in the short run. As per this model, bidirectional causation between external debt and GDP [24].
the external debt stock affect positively to economic growth Akashaya, had investigated the impact of external debt on
in Nigeria. Contrary to the ECM method the OLS regression economic growth in Ethiopia over the period 1981 to 2014.
model revealed that past debt stock has a significant negative The researcher used as explained variable real GDP Growth
impact on GDP. The result is in line with the priori rate and control variables external debt stock to GDP ratio,
theoretical expectation and indicates the debt overhang external debt service to export ratio, gross domestic
problem. Debt service rate has negative significant impact on investment to GDP ratio, human capital proxies by
GDP [18]. Onakoya and Ogunade, have assessed the link educational spending to GDP ratio, labor force as a share
between external debt and growth in Nigeria. The research total population and openness as factors used for the
applied Autoregressive distributed lag (ARDL) model to assessment of economic growth of Ethiopia. The study used
analyze the data covering from 1981 to 2014. The result VECM and co integration approach to estimate the mention
showed that external debt as well as debt servicing did not variable. The empirical result suggested that there exists a
have any significant impact both in the short run and in long long run relationship between external debt stock and GDP
run on economic growth of Nigeria [19]. Paul, investigated Growth in Ethiopia and revealed that external debt stock
the impact of external debt on economic growth in emerging contributes directly (positively) to the economic growth of
economy evidence from Nigeria. The study employed OLS Ethiopia [25].
regression technique and use the variable GDP, external debt Amsalu, also explored the function of debt (both external
stock, external debt servicing, external reserve and exchange debt stock and service) on economic growth in Ethiopia
rate. The result declared that debt stock has significant covering a period of about 35 years spanning from 1981 to

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ISSN: 2456-9992

2015 by using Johansen co-integration test and VECM. The Thus, the above theoretical relationship can be empirically
study also employed Granger causality test to check the modeled by incorporating the error term via regression
direction of the causation. The result of co integration test equation can be stated as;
using Johansen maximum likelihood technique revealed the
presence of multiple long run relationship between the debt
variables and GDP growth. The empirical estimation from
the Growth equation confirmed that external debt stock has a Where:
significant and positive long run relation to Ethiopian denotes the parameter or
economy as measured by the real GDP but for squaring it has coefficients used to estimate the model
significant and adverse relation with the GDP suggesting that : Real GDP at time t,
there exists a nonlinear linkage and it has a positive : Public external debt stock at period t,
contribution only up to some maximum level. External debt : Public external debt servicing at time t,
servicing on the other hand, has significant and negative : Capital stock at period t,
effect to the long run GDP growth of the country [26]. : Inflation rate at time t,
: Export at time t,
4. METHODOLOGY : Real effective exchange rate at period t,
: Trade openness at time t.
4.1 Data type and Collection Method
: Stochastic or error term at time t.
To analyze the impact of public external debt on economic : Natural logarithm
growth of Ethiopia, secondary time series data is used Autoregressive Distributed Lag (ARDL) Model
covering a period from 1971 to 2018. The required data for Most of the study that has been done in the past are adopted
the study area would collected from National Bank of the VECM, Johnson co integration, VAR and Granger
Ethiopia (NBE), ministry of finance and economic causality techniques. However, these approaches could not
development (MOFED), international monetary fund (IMF), have a valid outcome in small sample size [27]. Hence
World Bank (WB), world development indicator (WDI) and autoregressive distributed lag (ARDL) method of co
united nation conference for trade and development integration has more applicable than Johnson co integration
(UNCTAD). model.
3.2 Methods of Data analysis The reasons for using ARDL model are as follows:
 It does not require all variables to be integrated of
Both descriptive and econometric method of data analysis is
the same order I (1) as the Engle granger and
used. The study is explored the co-integration and long run
Johnson co-integration approach and it is still
relationship between the variables through Autoregressive
applicable irrespective of whether the underlying
Distributed Lag (ARDL) or Bound Test approach.
regressors are purely I (0), I (1) or mutually co
Furthermore, the causal relationships among the variables are
integrated.
checked via Granger causality test method. The econometric
part analyzed by using the latest version of Eviews versions  It is simple, allowing co integration relationship
11 statistical software packages. once the lag order of the model is identified.
Functional relationship and Model specification  It does not consider the problems arising from the
According to Sala-i-Martin (1997) suggested that, economic different order of integration of the variables.
theories are not enough to identify the explanatory variables  The test is relatively more efficient in small samples
that determine economic growth of a nation. As a result, the or finite sample data sizes.
researcher proposed a cross-sectional econometrics model as Long run co integration Error correction model and
follow; diagnostic test
After checking the co integration relationship among the
Where, represent a vector of economic growth rate variables and estimating the long run model, next step is to
denotes the constant (intercept) represents estimate the short run dynamic parameters and the
the coefficients and denotes a vector of adjustment coefficient that measure the speed of adjustment
potential explanatory variables which is vary from the study the equilibrium after a short term shocks by using the VEC
to study. model. The standard error correction model can be written as
Thus, economic growth of a nation does not only depend on follows:
the above-mentioned variables (physical capital, labor force,
∑ ∑
technological progress and human capital) rather there are
other variables that determine GDP.
this thesis tried to adopt the autoregressive distributed lag
∑ ∑
(ARDL) method of data estimation to explore the impact of
public external debt on economic growth of Ethiopia.
Therefore, the researcher included explanatory variables
∑ ∑
such as; public external debt stock (PED), public external
debt servicing (PEDS), capital stock or fixed capital
formation (K), inflation (INF), Export (EXP), real effective ∑
exchange rate (REER) and trade openness (TOP) on the
above GDP model. Mathematically it can be written as;

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ISSN: 2456-9992

, are Coefficients that amount of public external debt stock, which is used for
represents the short run dynamics of the model, financing the development of national project [29].
is error correction term lagged by one period, Figure 5.2 Trends of public external debt and economic
is error correction parameter that measure the speed of growth
adjustment towards the long run equilibrium after a short-run
disturbance. 70,000,000,000
60,000,000,000
5. DATA ANALYSIS AND DISCUSSION
5.1 Trends of public external debt and public external 50,000,000,000
debt servicing 40,000,000,000

The present value of total public debt stays well below the 30,000,000,000
indicative threshold of 56% of GDP in the baseline and 20,000,000,000
under most scenarios considered throughout the projection
period. The only alternative scenario where a breach occurs 10,000,000,000
is under the assumption of a primary fiscal balance -
throughout the simulation horizon fixed at its 2017/18 level.

1971

1986

2001
1974
1977
1980
1983

1989
1992
1995
1998

2004
2007
2010
2013
2016
However, the baseline assumes a gradual increase in
domestic interest rates to achieve positive real interest rates Real GDP Public External debt Stock
by the end of the DSA projection window. As a result, the
primary balance in the baseline increases gradually over The above figure shows the relationship between real GDP
time, as fiscal policy accommodates the increased financing and public external debt stock of Ethiopia over a period 1971
costs. In contrast, the fixed primary balance scenario implies to 2018. Hence, there exist an increment in real GDP and
a gradual widening of the fiscal deficit, contrary to the public external debt stock. Ethiopia’s impressive economic
authorities’ policy intentions and past record of prudent improvement recently has accompanied by social unrest and
budgetary policy. All indicators also show a declining trend widespread demonstrations in the Oromia and Amhara
after 2025/26 as public investment tapers off with the regions. The demonstrations exposed deep-rooted
completion of the large projects planned under the GTP II, developmental, social and political concerns with Ethiopia’s
and with it, the need for new borrowing slows as well [28]. state-driven model [30].

Fig 5.1 Stocks of Public External Debt in USD (1971- 5.2 Econometrics Analysis
30,000,000,000 2018)
5.2.1 Unit root Test
20,000,000,000 Most of time series data exhibit trending behavior or non-
stationary in the mean. Thus, investigating the existence of
10,000,000,000 unit root is the main task for time series model. The
- existence of unit root indicates that the data is non-stationary
while the absence of unit root revealed that the stochastic
1995
1971
1975
1979
1983
1987
1991

1999
2003
2007
2011
2015

process is stationary. Therefore, the researcher has

Stocks of Public External Debt performed the test to examine the stationary of the time
Source: World Bank, 2020 series data. The two most common trend removal or de-
The fig 5.1 shows that, there was a sharp decline in the trending procedures are first diff erence and time-trend
public external debt stock from the year 1999 to 2007. This regression. First diff erence is appropriate for I (1) time series
is due to the cancelation of public external debt to the poor and time-trend regression is appropriate for trend stationary I
countries and financial crisis at that time is another reason (0) time series. Unit root tests can be used to determine if
and together these led to a decline in the public external debt trending data should be first diff erenced or regressed on
stock in 2006 and the improvement to GDP ratio and it deterministic functions of time to render the data stationary.
declined to US$ 2.2 Billion (14.4% of GDP). However, the Moreover, economic and finance theory often suggests that
public external debt stock has continued to increase time to the existence of long-run equilibrium relationships among
time despite the several debt cancellation and restructuring non-stationary time series variables. The implementation of
initiatives that the country has gone through due to higher unit root is critical in the ARDL procedure in order to ensure
borrowing by public enterprises. In 2018, this figure that the variables are integrated at I (0) and I (1). Augmented
increased to US$ 27.3 Billion as shown in the figure. Dickey-Fuller (ADF) test and Philips-Peron (PP) unit root
5.2 Trends of real GDP growth and public external debt tests are used to check the order of integration among the
in Ethiopia variables. These tests are conducted for three alternative
Ethiopia is one of developing country in Africa and assisted specifications: intercept (constant) only, intercept & trend
its revenue through exports of primary commodities. Real and none (without trend and constant). See table 5.1
GDP growth retarded in the year 2017/18, because of partly
to civil unrest, political instability, and policy adjustments
that involved fiscal consolidation to stabilize the public
external debt. In attempting to support the available domestic
resources, the former successive government obtained huge

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Table 4.2 ADF Unit root test AIC selects the optimal lag length of each variable (lnrGDP,
lnPED, lnPEDS, lnK, INF,lnEXP, REER, TOP), respectively
ADF Test Statistics at
ADF Test Spastics at level and it is ARDL (3,1,1,0,0,2,2,0). This determination of the
1st difference
lag length is helpful to get the valid result and inferences.
Variab Trend
Trend and Figure 5.3 Optimal lag length for each variables
le intercept and none intercept
intercept
intercept
Akaike Information Criteria (top 20 models)
lnGDp 0.145 -1.379 1.52 -2.48 -4.51*** -3.05

-3.06
lnPED -1.779 -1.689 1.62 -4.72*** -4.75***
-3.07

lnPDS -0.167 -1.311 1.89 -6.76*** -6.76*** -3.08

-3.09
lnK 1.506 -1.113 3.01 -7.31*** -8.43***
-3.10

INF -5.35*** -5.40*** -1.32 -9.47*** -9.36*** -3.11

ARDL(3, 1, 1, 0, 0, 2, 2, 0)
ARDL(3, 1, 0, 0, 3, 2, 1, 0)
ARDL(3, 1, 1, 0, 2, 2, 2, 0)
ARDL(3, 1, 1, 0, 3, 2, 2, 0)
ARDL(3, 2, 0, 0, 3, 2, 1, 0)
ARDL(3, 0, 0, 0, 3, 2, 1, 0)
ARDL(3, 1, 1, 0, 3, 2, 1, 0)
ARDL(3, 1, 1, 0, 0, 3, 2, 0)
ARDL(3, 1, 3, 0, 0, 2, 2, 0)
ARDL(3, 1, 1, 0, 1, 2, 2, 0)
ARDL(3, 1, 2, 0, 0, 2, 2, 0)
ARDL(3, 1, 1, 0, 0, 2, 3, 0)
ARDL(3, 1, 1, 1, 0, 2, 2, 0)
ARDL(3, 1, 0, 0, 3, 3, 1, 0)
ARDL(3, 0, 1, 0, 0, 2, 2, 0)
ARDL(3, 2, 1, 0, 0, 2, 2, 0)
ARDL(3, 1, 0, 0, 3, 2, 2, 0)
ARDL(3, 1, 1, 0, 0, 2, 2, 1)
ARDL(3, 1, 1, 0, 2, 2, 1, 0)
ARDL(3, 1, 3, 0, 2, 2, 2, 0)
lnEXP -0.059 -3.507* 1.35 -12.6*** -12.25***
REER -3.211** -3.408* -0.55 -9.43*** -9.329***

TOP -1.854 -2.224 0.33 -7.35*** -7.35***

Source: output from Eviews 11, 2020
5.2.3 Estimation Result and Discussion
Mac Kinnon Critical values The preceding task in the ARDL approach to Co-integration
Critical values With intercept trend and is to test whether the presence of Co-integration or long run
intercept None relationship among the variables or not. As showed in the
ADF test statistics, the variables those had been included in
1% -3.588 -4.181
-2.618 real GDP model are making their stationary both at the level
I (0) and at the first difference I (1). The Bound test for co-
5% 2.929 -3.515 integration is run to investigate the joint significant of the
-1.948 coefficients in the specified conditional ARDL approach
10% 2.603 -3.188 model. Under this study the bound test for all variables are
-1.612 tested, with the null hypothesis of no co-integration against
the alternative of co-integration. Thus, the decision rule to
accept the null hypothesis (no co-integration) is, if the
Note that: ***, ** and * indicate the rejection of a null calculated F-statistics is found to be less or lower than the
hypothesis of non-stationary at 1%, 5% and 10% of upper and lower bound critical values. Conversely, we reject
significance level, respectively. Akaike information criterion the null hypothesis, if the F-statistics is greater than the
(AIC) is used to determine the lag length. upper bound and lower bound critical values, and we can
Source: - Output from Eviews 11, 2020 conclude that there is co-integration (long run relationship)
among the variables.
The decision rule of the above table is based on ADF critical
values. The output from ADF unit root test revealed that The result of bound test for spending effect model is
inflation rate (INF) is stationary at level with intercept only summarized in the following table.
and trend & intercept at all level of significance. Real Table 5.2 Bound Test for Co-integration
effective exchange rate (REER) and export (lnEXP) are also
stationary at zero lag with intercept or trend and intercept at ARDL Bounds Test
5% and 10% significance level respectively. The remaining Date: 11/30/19 Time: 11:01
variables are stationary at their first difference. In other word
none of the variables are stationary at their second difference Sample: 1974 2018
rather those variables are a mixture of I (0) and I (1) such Null Hypothesis: No long-run relationships exist
ADF test justified that using ARDL approach (bound test
approach of co-integration) is appropriate.
Test Statistic Value k
5.2.2 ARDL Model Lag length selection criteria
The issue of finding an appropriate lag length for each of the F-statistic 12.60098 7
underlying variables in the ARDL model is very important.
In this study Akaike information criterion (AIC) is conducted Critical Value Bounds
to determine the optimal lag length of each variable
automatically because it is a better choice for small sample
size data. Moreover, according to Pesaran and Shin (1999), Significance I0 Bound I1 Bound
for the annual time series data a maximum lag length is
recommended to choose the optimal lag for each variable. 10% 1.92 2.89
Therefore, in this paper a maximum lag length of 3 was
5% 2.17 3.21
chosen for the given ARDL model. Finally, in this model,

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 International Journal of Advanced Research and Publications
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2.5% 2.43 3.51 The coefficient of log of Public external debt servicing is
positive and statistically significance as shown in the above
1% 2.73 3.90
table. The result revealed that public external debt service is
fractions of scarce resources which are goes to for the
Source: - Output from Eviews11, 2020 repayment of foreign public debt payment that are not affect
The result from the above table 5.2 revealed that the F- the development spending, hence economic growth. The
statistics value (12.60098) is above or greater than both the coefficient of log public external debt servicing implies that
lower (I0 Bound) and the upper (I1 Bound) critical values at keeping other factor constant a 1 percent increase in the
1%, 2.5%, 5% and 10% level of significances. Therefore, we variable leads to 0.136 percentage increase in real GDP of
can reject the null hypothesis of no long run relationship Ethiopia in the long run. As expected and supported by many
among the variables instead we accept the alternatives of theories fixed capital formation (lnK) has direct positive
long run relationship or co-integration exists among the significant impact to economic growth of Ethiopia. As
variable at all level of significance. shown from table 5.3, other things remain the same a 1
percent increase in the capital stock leads to a 0.270 percent
5.2.4 Long Run Estimation increase in real GDP. It is known that capital plays a
Once we assured the existence of long run relationship or co- significant role in modern productivity; production without
integration among the variables the next step will be capital is unthinkable or difficult for every nation. With the
estimating the long run relationship among log of real GDP, growth of technology and specialization, capital becomes
log of public external debt stock, log of public external debt more complex and advanced type. More goods are produced
servicing, log of capital stock, inflation rate, log of export, with the use of capital. The greatest productivity of advanced
real effective exchange rate and trade openness. Then next or developed nation is mainly due to extensive use of capital.
critical step is estimating the long run coefficient of real A raise in capital investment is likely to increase labor
GDP (lnrGDP) on its regressors. The result is reported as productivity if it promotes technological progress. This leads
bellow; to an increase in aggregate output that results an
As indicated on the table log of public external debt stock improvement in real GDP of the economy.
(lnPED) has highly significant negative impact on log of real Inconsistent with the prior expectation inflation rate is
GDP or economic growth of Ethiopia. The coefficient (- significant positive impact to economic growth with a very
0.133) implies that a 1 percent increase in public external little coefficient (0.004) which is nearly zero thus, other
debt stock, holding other things remain constant, leads to a things being equal a 1 percent increase in inflation rate leads
0.133 percent decline in real GDP of Ethiopia in the long to 0.04 percent increases in the real GDP of Ethiopia in the
run. Moreover, this significant negative influence revealed long run.
that the greater the stock of public external debt, the more The variable log export (lnEXP) is one of the main
economic growth worsens. The inverse relationship between deterministic factors that influence real GDP. As a priori
public external debt stock and real GDP is partly due to the expectation and supported by many theories and empirical
use of public external borrowing on nonproductive activities findings the coefficient of lnEXP is highly significant
as verified by the literatures. On the other hand, a greatest positive impact on economic growth of Ethiopia. A theory
amount of public external debt is going to the repayment of goes back to the Classical economies theory by Adam Smith
past accumulated public external debt stock rather than and David Ricardo, who argued that international trade plays
boosting domestic investment. This result also in line with significant role in enhancing economic growth. It was also
high public external debt stock is associated with low recognized that export filled the need of foreign exchange.
economic performance, as a higher tax burden on capital is Other things being constant a 1 percent increase in export
needed to service the accumulated public debt. This scenario leads to 0.534 percent increases in real GDP in the long run.
leads to a lower rate of return from capital resulted to lower In a similar fashion, real effective exchange rate (REER) has
investment, broaden the dead weight loss and finally lower also positive significant impact to real GDP with a meager
economic growth coefficient. Other things remain the same a 1 percent
increase in real effective exchange rate leads to a 0.03
Table 5.3 Long run coefficients of real GDP mode increase in real GDP. This implies that an increase in real
effective exchange rate that is depreciation of Ethiopian birr
Long Run Coefficients promotes economic growth of Ethiopia through enhancing
international competitiveness. This result is also in line with
Variable Coefficient Std. Error t-Statistic Prob. the traditional view of exchange rate. This approach states
that depreciation has expansionary effect on economic
LNPED -0.133195 0.031734 -4.197194 0.0002*** growth through aggregate demand channel. It means that
LNPEDS 0.135693 0.034598 3.921991 0.0005*** depreciation of currency will make domestic goods relatively
LNK 0.270006 0.049610 5.442543 0.0000*** cheaper in international market and this will improve export
INF 0.004925 0.001295 3.804835 0.0007*** performance that leads to in correcting the difficulties of
LNEXP 0.534379 0.092677 5.766048 0.0000*** balance of payment which finally promote economic growth
REER 0.003430 0.000466 7.352049 0.0000*** of Ethiopia.
TOP -0.715845 0.809931 -0.883835 0.3843 In the above real GDP model the last variable but the result
C 6.068001 0.784930 7.730622 0.0000*** was not expected as actual is trade openness that is negative
but insignificant impact to economic growth. A possible
Source: - Output from Eviews 11, 2020 justification is that the country’s export sector could not able
Note: - The sign *** shows that significance of the to perform well during the period under study. As a result,
coefficient at 1% level. the volume of import is excessively higher than the volume

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of import. In addition, the large proportions of imports are (REER) also has direct significant impact with a lowest
containing consumer goods instead of capital goods and coefficient 0.001 as shown on the above table 4.6.
technologies. Thus, trade openness retard Ethiopian Real gross domestic product, export and real effective
economic growth instead of supporting it. exchange rate are affected by the lagged value of itself and
the results are statically significant.
5.2.4 Short Run Dynamic Error Correction Estimates A pervasive parameter to note in the estimation of Error
The included variables in the model are co-integrated in the Correction model (ECM) is the coefficient of adjustment,
long run, thus, it shows the existence of an error correction which in this study, measures the speed of adjustment in the
mechanism that bring together the long run linkage with its real GDP following a shock in the system. It can also be seen
short run dynamic adjustment. as a measure of the degree of adjustment of the actual real
ARDL Error Correction Regression GDP with regard to its equilibrium level. As shown on the
Dependent Variable: D(LNRGDP) above table 5.4 the value, -0.7828, is ECM coefficient which
Selected Model: ARDL(3, 1, 1, 0, 0, 2, 2, 0) shows how quickly variables converge to equilibrium from
Date: 11/30/19 Time: 23:16 shocks. Thus, the output for real GDP shows that the
Sample: 1971 2018 expected negative sign of error correction is highly
Included observations: 45 significant. This confirms the existence of long run
relationship among the variables with their various
ECM Regression significant lags. Approximately 78.28% of the disequilibrium
from the previous year’s shocks converges back to the long
Variable Coefficient Std. Error t-Statistic Prob. run equilibrium in the current year. The coefficients of the
error correction term in the above table 5.4 shows that real
D(LNRGDP(-1)) 0.391489 0.068950 5.677863 0.0000*** GDP has the significant coefficient at 1% level, with a t-
D(LNRGDP(-2)) -0.188142 0.058904 -3.194067 0.0035*** value of -12.075, and has a correct negative sign. This
D(LNPED) -0.050126 0.023347 -2.146976 0.0406** suggests that the real GDP equation constitutes the true co-
D(LNPEDS) 0.043361 0.019041 2.277255 0.0306** integrating relationship.
D(LNEXP) 0.202318 0.036391 5.559506 0.0000*** 5.2.5 Long run Residual Diagnostics and Stability for real
D(LNEXP(-1)) -0.155945 0.044915 -3.471987 0.0017*** GDP model
D(REER) 0.000956 0.000169 5.652021 0.0000*** 5.2.5.1 Residual Diagnostics
D(REER(-1)) -0.000667 0.000237 -2.818385 0.0088***
After estimation of the long run and short run model,
CointEq(-1)* -0.782871 0.064833 -12.07524 0.0000***
deploying various diagnostic tests is a mandatory step in
time series data. Diagnostic testing provides information
R-squared 0.909794 Mean dependent var 0.070019
regarding how these data might be modeled and in order to
R-squared 0.909794 Mean dependent var 0.070019
test the standard property of the model. In this study,
Adjusted R-squared 0.889748 S.D. dependent var 0.118242
diagnostic tests that would provide explanation for the
S.E. of regression 0.039261 Akaike info criterion -3.460293
existence of serial correlation (Brush and Godfray LM test),
Sum squared resid 0.055492 Schwarz criterion -3.098961
functional misspecification test (Ramsey’s RESET test), test
Log likelihood 86.85660 Hannan-Quinn criter. -3.325592
Durbin-Watson stat 1.880113
for normality (Jaque-Bera test), heteroscedasticity (Breusch-
Adjusted R-squared 0.889748 S.D. dependent var 0.118242 Pagan-Godfrey test) and also CUMSUM recursive and
S.E. of regression 0.039261 Akaike info criterion -3.460293 CUMSUM square recursive residual tests are applied to test
Sum squared resid 0.055492 Schwarz criterion -3.098961 the overall stability of the long run and short run coefficients.
Log likelihood 86.85660 Hannan-Quinn criter. -3.325592 I. Serial correlation test: is applied to test whether the
Durbin-Watson stat 1.880113 residual is serially correlated or not. If the residual is not
serially correlated our model is becoming the best model.
Note: - the sign *** and ** indicates that 1% and 5% level Dissimilar the Durbin-Watson statistic for AR (1) errors, the
of significance. serial correlation LM test could be used to test for higher
Source: - Output from Eviews 11, 2020 order ARMA errors and is applicable whether there are
lagged dependent variables or not. A generalization of this
The above ARDL short run estimates shows that with procedure that helps for testing of higher- order
consistent to the long run output public external debt stock is autoregressive disturbance is the LM test of Breusch pagan
significant and negative impact to real GDP. A 1 percent and Godfrey test. In this (LM test) the regression is
increase in lnPED leads to 0.05 percentage decrease in the augmented with p lagged residual series. The null hypothesis
growth of a country in the short run. Similarly, public of the test is that there is no serial correlation in residuals up
external debt servicing is also significant positive impact to to the identified order against the alternative hypothesis and
real GDP. A 1 percent increases in lnPEDS results a 0.04 the decision rule is that accept the null hypothesis if F-
percent improvement on economic growth. calculated is less than F-tabulated however reject the null
In the short run both the variable log of export and real hypothesis if F-calculated higher than F-critical values. The
effective exchange rate is positive and significant impact result is summarized on bellow table.
similar to the long run effects. The positive coefficient of
export revealed that other things remain equal a 1 percent A table 4.8 result indicates that the p-value is more than 5
increase in lnEXP leads to 0.20 increase in economic growth percent; we can’t reject the null hypothesis. Our null
of Ethiopia in the short run. An export is beneficial for an hypothesis is, there is no serial correlation. Therefore, the
economy through allowing domestic producers to gain model is best model. Hence, the test accepts the hypothesis
ownership advantage and develop low cost and enables to of no serial correlation up to order two, with a p value 0.804.
produce differentiated product. Real effective exchange rate

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ISSN: 2456-9992

Where p is a pre-specified integer or no serial correlation failing to reject the null hypothesis. Our null hypothesis is
between residuals based on the probability F statistic. that the residuals are normally distributed. This means that
II. Heteroscedasticity Test: There are number of the error terms are normally distribute with mean zero and
heteroscedasticity tests in order to check the problem of constant variance and the relationship between the variables
heteroscedasticity. For this study, we employ the brush is confirmable.
Test Chi- Square P-value
Serial correlation 0.6883 0.8044
Table 4.8 Diagnostics test
Heteroscedasticity 0.5809 0.6643 1. 4
Normality Not applicable 0.792136
A. Lagrange multiplier test of residual serial correlation 4.2.6.2 Stability Test
B. Based on the regression of squared residuals on squared
fitted values Finally, to ensure that the model is stable or not and to check
C. Based on a test of skewness and kurtosis of residuals the functional form of the model we conducted the stability
pagan Godfrey test of heteroscedasticity. This set of tests test.
allows whether the residual is heteroscedasticity or not, that A. Ramsey RESET Test: this test helps us to check the
means to be a best model the residual must be functional form of our model which indicates
homoscedasticity. whether the models are well constructed or not. The
In the above table 5.5 result shows that the P-value is 0.664 output from the bellow (table 4.9) shows that the P-
which is more than 5 percent, meaning that we can’t reject value is 0.693 (69.3 percent) which is more than 5
the null hypothesis. Our null hypothesis is that residual has percent. Hence, we can’t reject the null hypothesis
not a problem of heteroscedasticity or the residual is of Ramsey RESET test. The result revealed that the
homoscedastic. Therefore, our model is best. model did not have omitted variable bias and the
III. Normality Test: this test is conducted to check whether models are well constructed. Moreover, with this
the residuals are normally distributed or not by applying value, the test result of F statistics reveals that fail
Jarque-Bera normality test. It is a goodness of fit that shows to reject the null hypothesis. These stated that the
weather the data sample has skewness and kurtosis. This test error terms are normally and independently
is summarized in the bellow figure. distributed with zero mean and constant variance
Output from the above table 4.8 shows that the P-value is and the researcher concluded that the model is
0.79 (79 percent), which is more than 5 percent, implies that stable.

Ramsey RESET Test

Equation: UNTITLED
Omitted Variables: Squares of fitted values
Specification: LNRGDP LNRGDP(-1) LNRGDP(-2) LNRGDP(-3) LNPED
LNPED(-1) LNPEDS LNPEDS(-1) LNK INF LNEXP LNEXP(-1) LNEXP(
-2) REER REER(-1) REER(-2) TOP C

d
Value fProbability

2
t-statistic 0.399188 70.6929
(
1
,

2
7
F-statistic 0.159351 )0.6929

Likelihood ratio 0.264805 10.6068

F-test summary:
Sum of Sq. df Mean Squares
Test SSR 0.000326 1 0.000326
Restricted SSR 0.055492 28 0.001982
Unrestricted SSR 0.055167 27 0.002043

LR test summary:
Value

Restricted LogL 86.85660

Unrestricted LogL 86.98900

Source: - Output from Eviews 11

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 International Journal of Advanced Research and Publications
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B. CUMSUM recursive and CUMSUM square correctly specified and the model is stable. Furthermore, the
recursive: To test a structural stability of the short result indicates that there is no structural instability in the
run and long run relationship model, there are model during the sample period. Thus, one can conclude that
various tests based on recursive residual. The two long and short run estimates are quite stable and as well there
most important common recursive residuals is no any structural break as revealed from the results
(CUMSUM) and cumulative sum of squares estimated model are efficient and reliable.
recursive residuals (CUMSUMSQ) which are
recommended by (Pesaran and Shin, 1999, 2001). 6. CONCLUSION AND RECOMMENDATION
The CUMSUM test is conducted by plotting the
sum of the recursive residual. If this sum goes 6.1 Conclusion
outside the critical bound, we conclude that there
was a structural break at the point at which the sum The main aim of this study is to investigate the impact of
began its movement towards the bound. Hence, for public external debt stock on economic growth of Ethiopia
the stability test the graph plots both the cumulative for the period from 1971 to 2018. The major contribution of
sum of residual with 5 percent critical lines. this investigation is that, unlike other previous researchers
Moreover, if the cumulative sum remains inside who used external debt at an aggregate level, this study has
between the two critical lines or bounds back after it seen the separate impact of the government or public
is out of the boundary lines, the null hypothesis of external debt. It is known that total external debt is the
correct specification of the model cannot be summation of private and public external debt.
rejected. But, if the cumulative sum goes outside The study tried to explore the profile of Ethiopian public
between the two critical bounds there exists series external debt and the repayment profile by using descriptive
parameter instability problem. The straight lines statistics in the form of graphs and tables. And it sought to
represent critical bounds at 5% level of significance. make a long-run relationship between public external debt
This scenario is summarized on the bellow figure. stocked and public external debt servicing payment on
economic growth in the country. The model adds other
Figure 5.5 CUMSUM recursive relevant time series variables such as fixed capital formation,
16
inflation rate as a proxy of consumer price index, export of
12
8
goods and services, real effective exchange rate (REER) and
4 trade openness for empirical analysis. First of all, stationary
0 of time series was tested by applying the Augmented
-4
-8
Dickey-Fuller (ADF) and Philips- Perron (PP) unit root test.
-12 The variables are found to be mixture of integrated of order
-16
92 94 96 98 00 02 04 06 08 10 12 14 16 18
one and zero i.e. I (1) and I (0).
CUSUM 5% Significance
In order to answer the objective of this study, the
autoregressive distributive lag (ARDL) bound test modeling
As depicted in the (figure 5.5) above, the plot of cumulative approach to co-integration, error correction model (ECM)
sum of recursive residuals graphical test of stability revealed and Eangle Granger causality test have been used. Based on
by oscillation of the calculated statistics between the critical the empirical analysis and findings, the following inferences
bounds at 5% level of significance and it is the indication of are derived.
stable parameters under study. The CUMSUM of squares The empirical analysis output revealed that a significant
test is the same with the CUMSUM test, but plots the negative long run impact exist between public external debt
cumulative sum of squared recursive residuals, depicted as a stock and economic growth, the adverse effect implies that,
fraction of these squared residuals summed over all high level of public external debt stock poses a great
observations. The straight lines represent critical bounds at challenge for the growth of a country. It is mainly due to
5% level of significance. improper use of this financial resource, used for
This is re plotted by the same pattern of the graph of nonproductive activities and the funds are not always
cumulative sum of the squares of recursive residuals shown associated with real productive sectors. On the other hand, a
in the figure below. significant part of public external debt is deducting to repay
previous other debts stock rather than to enhance capital
1.4
1.2
investment in Ethiopia. Hence, higher tax burden on capital
1.0 is required to repay this stock of public external debt, which
0.8
0.6
results to a lower rate of return on capital, and hence lower
0.4 investment and economic improvement in the country. Thus,
0.2
0.0
reducing the stock of external debt is mandatory to maintain
-0.2 economic growth in Ethiopia.
-0.4
92 94 96 98 00 02 04 06 08 10 12 14 16 18
Inconsistent with many studies, unexpectedly the coefficient
CUSUM of Squares 5% Significance
of Public external debt servicing is positive and statistically
significance. The result revealed that public external debt
Source: output from Eviews 11 software service is fractions of scarce resources which is goes to for
the repayment of foreign public debt payment that are not
The above graph shows that CUMSUMSQ stay within the affect the development spending, hence economic growth.
lines, and, consequently, this confirms the equation is

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Moreover, capital stock or fixed capital formation has a  Dependence on external financial resource is both
direct positive significant impact to economic growth of risky and unreliable thus, the government needs to
Ethiopia. Capital plays a significant role in modern mobilize its own resource domestically and need to
productivity; production without capital is unthinkable or design policies regarding to reducing its exposure to
difficult for every nation. With the growth of technology and external debt stock in order to reduce its adverse
specialization, capital becomes more complex and advanced impact on the economy.
type. More goods are produced with the use of capital. The
greatest productivity of advanced or developed nation is  The government of Ethiopia should minimize the
mainly due to extensive use of capital. Inflation rate also has reliance on external borrowing by maximizing tax
a positive significant impact with the smallest coefficient revenue collection through combating the illegal
value which indicates a meager contribution to the economy usage of taxes like tax avoidance and tax evasion in
of Ethiopia. Export exerts a direct significance positive effect order to finance both recurrent and capital
to GDP of Ethiopia which is supported by many theories and expenditure.
empirical findings. It was also recognized that export filled  The government of Ethiopia and policy makers to
the need of foreign exchange. The variable real effective know the threshold level of public external debt is
exchange rate (REER) has positive significant impact to essential. This is due to reasonable public external
economic growth of Ethiopia. The positive direct effect is borrowing can enhance economic growth through
due to depreciation of currency will make domestic goods capital accumulation and improved productivity of
relatively cheaper in international market and this will the country.
improve export performance which leads to in correcting the  In order to reduce the public external debt burden,
difficulties of balance of payment which finally promote the policy makers should design those policies and
economic growth of Ethiopia. From this study the last strategies that enhance the exports of country and
explanatory variable is trade openness which has adverse reduce imports of luxuries goods and also they
insignificant effect on the growth of Ethiopia. should conduct those measures which minimize
The short-run dynamic ARDL regression output also fiscal deficit so as to tackling the problem of severe
indicates that, the speed of adjustment of any disequilibrium external debt burden.
towards long-run equilibrium or the equilibrium error  The government should ensure economic, political
correction coefficient found out (-0.7828) is highly stability and stop civil unrest in order to benefit
significant which suggest that about 78.28 percent yearly from sustained foreign capital flows particularly
adjustment towards long run equilibrium. It implies a very foreign loans and foreign direct investments but
high speed of adjustment to equilibrium after a shock; highly debt burden should be made minimal.
significant error correction term further confirms the
existence of a stable long run relationship. References
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