Modelling external debt – growth nexus: how relevant is governance?
| Pages | 1323-1340 |
| DOI | https://doi.org/10.1108/JFC-05-2020-0078 |
| Date | 10 August 2020 |
| Published date | 10 August 2020 |
| Author | Waliu Olawale Shittu,Nor Asmat Ismail,Abdul Rais Abdul Latiff,Hammed Oluwaseyi Musibau |
| Subject Matter | Financial risk/company failure,Financial crime |
Modelling external debt –growth
nexus: how relevant is
governance?
Waliu Olawale Shittu,Nor Asmat Ismail and
Abdul Rais Abdul Latiff
Department of Economics, School of Social Sciences, Universiti Sains Malaysia,
Gelugor, Pulau-Pinang, Malaysia, and
Hammed Oluwaseyi Musibau
Tasmanian School of Economics and Business, University of Tasmania,
Launceston, Australia
Abstract
Purpose –Amongst the major concerns of sub-Sahara Africa are the rising external debt and poor
performances in governance. This paper aims to lend a voice to the relevanceof governance on the relationship
between external debt and economic growth in selected five sub-Saharan African(SSA) countries.
Design/methodology/approach –Using available data from the World Governance and Development
Indicators, between 1996 and 2016, the study uses the fully-modified OLS technique after establishing the
absence of unit rootand existence of long-run relationship amongst the variables of the model.
Findings –The findings confirm a non-linear relationship between external debt and economic with a
positive neteffect of $5.05 increase in economic performance fora US$ rise in externaldebt. While the index of
governance depicts a negative association with economic growth, the indicators show mixed results. The
interaction effect of external debt and governance on economic performance explain that improved
governance quality reducesits negative effect on economic performance by US$1.288 (witha total effect of –
4.180þ1.288*EXDBT); it equally enhances the (net)positive impact of external debt by US$1.288 (with a total
effect 5.05þ1.288*IQ).
Practical implications –The governments of the selected countries are, therefore, advised to seek
other means of financing their expenditure while curbing financial mism anagement and its long-term
impacts on growth. Also, governance infrastructures should be improved torestore both domestic and
foreign investors’confidence so that more private capitals may be attracted in lieu of excessive
borrowings.
Originality/value –The research is the first to comprehensively examine the nexus betweenexternal
debt, governance and economic growth in the selected countries, given their external debtposition in
SSA. This includes examining the impacts of each of the governance indicators and the comprehensive
index of governance on growth. Furthermore, the study adds to the literature by exam ining the
interaction effects of external debt and governance on economic growth of these countries. This gives
both the partial and total estimates of the effects of external debt and governance on economicgrowth in
the countries under consideration.
Keywords Governance, Sub-Sahara Africa, Economic growth, External debt
Paper type Research paper
JEL classification –H63, E02, O43
The authors appreciate the journal editor for consideration, and the anonymous reviewers for a good
job.
Modelling
external debt
1323
Journalof Financial Crime
Vol.27 No. 4, 2020
pp. 1323-1340
© Emerald Publishing Limited
1359-0790
DOI 10.1108/JFC-05-2020-0078
The current issue and full text archive of this journal is available on Emerald Insight at:
https://www.emerald.com/insight/1359-0790.htm
1. Background of the study
The use of external borrowings, at sustainable levels, largely stimulates growth and
development when they are used productively. External debt is incurred whenan economy
is exposed to shortages of foreign exchange and domestic savings necessary for achieving
her developmental and other nationalobjectives (Siddique et al.,2015). Debt accummulation,
however, involves various risks; as debt rises, the repayment abilities of the borrowers
become increasingly responsive to fall in income, while interest rates increase. It equally
hinders governments’incentives to engage in costly and difficult policy reforms at
improving technology and efficient resources utilisation which result in slower growth in
productivity. In other words, increasedlevel of debt raises the likelihood of defaults, retards
economic activities –thus, resulting in financial fragility and declining growth rate
(Cecchetti et al.,2011 and Poirson et al., 2004 cited in Karadam, 2018;Karadam, 2018).
A large number of African countriesare still battling with debt service problems despite
having achieved the debt sustainability level suggested by the highly-indebted poor
countries’(HIPC) initiative. The persistence of unsustainable indebtedness amongst many
African countries has, therefore, defeated the growth and development prospects. This is
largely attributedto (amongst others) poor domestic resources mobilisation,inadequate debt
management capacity, as well as weak institutional and governance infrastructures.
Inefficient governance infrastructure has been identified as one of the major barriers to
external debt sustainability in Africa (Muhanji and Ojah, 2011). While debt level assumes
different role on growth based on an economy’s income-level, high degrees of openness and
quality institutions, as well as a more-developed financial system nature of high-income
countries, largely make them more resilient to high levels of debt than the low-income
countries which are more volatile and fragile at high debt stock levels as a result of their
economic, structural and institutional inefficiencies. This means that the case in developing
(including African) economies is such that public debt is detrimental to economic growth at
lower (optimal) levels of debt as a result of their under-developed financial markets, lower
degrees of institutional quality and openness –when compared to industrialised economies
(Karadam, 2018). In Figure 1, the trends of external debt vis-à-vis economic growth is
examinedfor each of the five countries –Malawi, Uganda,Nigeria, Kenya and South Africa –
from 2010 to 2017. While the countries continually accumulate foreign debt over time, no
stable and significant growth rateis experienced in any of the countries, except a continually
declininggrowth rate and recession (in the caseof Nigeria in 2016).
As highlighted in Gurvich (2016), theprimary reason behind the variations in per capita
income across countries is the difference in their (economic) institutional quality as a result
of its effects on growth and development. Inefficient (economic) institutions undermine the
desires for companies’profits reinvestments and reduces the net capital inflows. The
various reports on governancein the selected sub-Saharan African (SSA) countries, amongst
other African countries, uphold the assertion that the levels of corruption and economic
mismanagement; amongst other indicators, are alarming. As detailed in Table 1, with the
exception of South Africa which depictsvery few positive estimates (but very low scores on
voice and accountability, governmenteffectiveness and regulatory quality), each of the five
countries largely ranks negative in the estimates of all governance indicators –including
political stability,rule of law, corruption, voice and accountability, government effectiveness
and regulatory quality between 2010 and 2017 (World Bank, 2017b). These reflects the
extent of their political, economic and institutional imbalances. As noted by Mauro (1995),
experience from the less-developed countries show that they tend to be more corrupt and
politically unstable, whencompared to high income countries. With this in place, employees
may be forced into rent-seekingactivities with its predictable consequences for growth and
JFC
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