Academic journal article Advances in Management

Case Study: Does Debt Provide Economic Growth in Central Asian Economies?

Academic journal article Advances in Management

Case Study: Does Debt Provide Economic Growth in Central Asian Economies?

Article excerpt

Introduction

Both economic growth and social growth occupy a very important place among the general aims of economies. One of the vital priorities is that domestic production needs to be boosted in order to sustain such growth. To lift up domestic production, it is crucial to transfer capital stock into investments. However, in the context of developing countries, capital is a rare resource and the amount of savings necessary to raise capital is generally insufficient or locally unavailable.

Hence, low savings lead to low investments, low investment leads to low income and low income leads back to low savings. This cycle generates convoluted effects. To break this vicious cycle, an external intervention may be required and thus foreign debt may serve as a solution. Due to the requirement that some investment goods will be exported, the demand for foreign currency may be inevitable. This circumstance of certain economies is called "twin deficits'. In order to increase their countries' welfare, two major problems encountered by developing countries are "savings deficit' and "balance of payment deficit'.

Developing countries appeal for a large amount of foreign financial resources for their economic growth due to deficits in the country's domestic resources. Thus, they attempt to finance these requirements with foreign debt or international financial aid13.

Local people and institutions may apply for foreign debt from foreign creditors, also known as credit supply, for such purposes as to cover resource/savings deficit foreign trade and balance of payments deficit, and budget deficit; to provide finance for defense expenditures; to finance great investments, reforms and any other factors to provide and protect economic equilibrium; to fund due debts and eventually to meet unexpected expenses (natural catastrophes, wars etc.)

Keynes, who advocates the necessity of government interference to economic development, claims that foreign debt offers great contributions to financial growth and that government intervention is necessary for a higher level of economic development. Harrod-Domar also references this relationship and also states that foreign aid increases investment rates due to its being a source for higher savings rate. Higher investment leads to an increase in the rate of growth, finally pushing up the level of income.15 In addition, foreign debt may yield better results in economies where marginal efficiency of capital is higher.

Foreign debt is generally considered to contribute to economic development. On the other side, impacts of foreign debt on the economy are not quite certain. To turn the effect positive, such factors as efficient utilization of external debt, absorptive capacity of that particular economy, balance of payments, and terms for foreign loans are to be taken into consideration. At this point, Lin and Kim18 emphasize that although long term foreign debt diminishes both capital stock and future economic development, during the repayme nt period of foreign loan, it instigates an increase in both current capital stock and economic development. Kozali7 affirms that it has been a common practice that foreign financial aid should be sought as long as it fosters real production according to the scale for absorptive capacity.

On the other hand, higher debt after a certain point may damage economic development, generating an isolation effect on domestic and foreign direct investments. Such a circumstance originates from higher tax expectations by investors4. The theory of debt overhang explains that a high level of debt stock has a negative impact on economic development. Keeping that in mind, in the case that the debt owed is much higher than the repayment capacity, "expected debt service cost' naturally hinders local and foreign direct investments. Prospective investors assess this particular circumstance reasoning that if they acquire more profits from the increase in their production, they will have to pay higher taxes which will eventually be used to cover the country's foreign debt25. …

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