This study uses panel data for 29 Heavily Indebted Poor Countries (HIPCs) from 1984 to 2000 to examine the dynamic relationships between growth of external debts with other determinant variables (exchange rate, interest payment on debt, and non-interest current account balance) and control variables such as governance indicators. The fixed- and random-effect models were used to investigate these relationships. First, the results show that high interest payments have adverse effects on the growth of external debts. Second, real exchange rates have positive influence on growth of external debts. Third, corruption is found to distort economic growth and reduces the efficiency of the public sector. Finally, stability index contributes negatively to the growth of external debts. Therefore, given these dynamic relationships; this study suggests that there are strong correlation between growth of external debts and exchange rate policy, interest payments and some governance indicators. This evidence may partially explain the explosive external debt position of the HIPCs.
The world witnessed unprecedented explosion in public debt throughout the 1980s and the 1990s in developing countries, especially those of the Heavily Indebted Poor Countries (HIPCs). Most of the public debt holdings of developing countries are external debts. In most of these countries the share of debt in gross domestic product grew over time (see Figures 1 and 2). In fact, most of these countries face external debt that is more than two times the size of their gross domestic product. Due to scarce foreign exchange in most of these countries, efforts to service the debt consumed large shares of their government revenues. As the debt burden increases, these countries must allocate a greater portion of their revenues to service external debts, resulting in higher taxes, more borrowing, and eventually debt default.
The severe difficulties that most HIPCs faced in servicing their external debts resulted in the persistent accumulation of arrears, which are unpaid debt service obligations. Despite several repeated attempts at rescheduling, many HIPCs have not been able to meet their debt service obligations fully and on time for several years.
The worldwide economic growth slowdown has resulted in an increase in the level of debt burden, especially in the 1980s and 1990s (Easterly, 2001). This is partly because these countries have low incomes and their economies tend to grow slower than those of the higher income countries. Slower economic growth poses problems in expanding exports and delays progress in debt restructuring. This, in turn, impedes flows of capital to HIPCs. The massive external debts of these countries have reduced the inflows of foreign direct investment, employment, and growth of their economies and therefore have become a stumbling block to sustainable development.
In light of the above, this paper attempts to address the primary questions including: What are the factors behind the growth of external debts of the HIPCs? What are the consequences of massive external debts for these countries? What are the correlating effects within the factors themselves, so as to determine future patterns?
Over the years, the issue of public debt has occupied primary importance in both local and international arenas. Claessen, et al (1997) argued that HIPCs are characterized not only by high debt relative to income, but also by relatively poor economic performance. The reason is the combination effect of the large inflows of concessional finance despite the emerging debt burden and low growth rates of output and exports. In addition, the poor economic performance in these countries could be attributed to adverse terms of trade development, civil and political unrest, weak macroeconomic management, and inefficient allocation of resources.
The most recent article by Easterly (2001) confirmed that the slowing down of economic growth in the past decades since 1975 can be attributed to the increases in the burden of public debts in most middle income countries and HIPCs. …