Deva Res

WOLKITE UNIVERSITY
COLLEGE OF BUSSINESS AND ECONOMICS
DEPARTMENT OF ECONOMICS
IMPACT OF EXTERNAL DEBT ON ETHIOPIA ECONOMIC GROWTH
A Research Submitted to the Department of Economics School of Graduate

Studies of Wolkite University in Partial Requirement for the bachelor Degree in
Art of economics
By: DAWIT GETACHEW
ID No: SSR/1222/13
ADVISOR: Dr. ABDULAZIZ A
April, 2024
WOLKITE, ETHIOPIA
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Board of examiners Approval sheet
This is to certify that this senior research paper prepared by DAWIT GETACHEW entitled
"IMPACT OF EXTERNAL DEBT ON ETHIOPIAN ECONOMIC GROWTH” submitted
in partial fulfillment of the requirement for the degree of Bachelor of art in Economics complies
with the regulations of the university meets the accepted standards with respect of originality and
equity.
Signed by Board of examiners:
Examiner: ______________________; Signature: _________________; Date:

_______________
Examiner: ______________________; Signature: _________________; Date:

_______________
Advisor: _______________________; Signature: _________________; Date:

_______________
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ACKNOWLEDGEMENTS
First and foremost, I want to express my profound gratitude to Almighty God who enabled me
with his divine mercy to go through this academic journey and arrived successfully at the end
with sound health.
Second, my sincere gratitude goes to my supervisor, Dr. ABDULAZIZ A for his constructive
criticisms, suggestions and corrections that helped shaped the work. Third, I am also much
grateful and warmest appreciation goes to my Dad GETACHEW WOLDE, my mum FANTU
BERTAWE, my siblings and my uncle MELAKU BERTAWE for their help and financial and
moral support in all academics achievements. My appreciation also goes to my cousin
BEREKET MELAKU for the academic knowledge, suggestions and advice given to me before,
during, and after the various departmental and faculty research work. Finally, to my special
friends; MEKBIB MESFIN and ANDAMLAK GEBREMARIAM in all ways.
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Abstract
This paper examines the long run and short run relationship between external debt and
economic growth in Ethiopia using time series data for the period 2001 to 2021. To this end, the
descriptive and regression analysis were used. Using the long run co-integration test of ordinary
least square (OLS) method and short run error correction model (ECM), the findings of the
study revealed that external debt was negatively and significantly related to the economic
growth both in short run and long run. This indicated the existence of debt overhang problem in
the country. But, the other debt burden indicating variable, external debt service export ratio
positively but significantly related to economic growth which shows the absence of crowding out
effect. The study also tested for time series behaviours like presence of stationarity, co-
integration, multicollinearity, autocorrelation, heteroskedasticity and model specification
problems to guard against spurious results. The researcher recommends that External debt
ought to be utilized properly and wisely by being invested on prioritized and most productive
investment, only be contracted when it is really needed to finance projects or investments that
will significantly contribute for the growth and development of the economy, and channel the
borrowed fund to the productive real sectors of the economy rather than social consumption.
Keywords: Key Words: External Debt, Debt overhang, Debt crowding out, debt servicing
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Contents
Board of examiners Approval sheet.............................................................................................................i
ACKNOWLEDGEMENTS...............................................................................................................................ii
Abstract......................................................................................................................................................iii
List of tables ............................................................................................................................................. iv

List of Figures ............................................................................................................................................. iv
List of Appendixes ..................................................................................................................................... iv
ACRONYMS ................................................................................................................................................. v
CHAPTER ONE ............................................................................................................................................ 1
1. INTRODUCTION .................................................................................................................................. 1
1.1. Background of the Study ................................................................................................... 1
1.2. Statement of the problem ................................................................................................ 2
1.3. Research questions ........................................................................................................... 3
1.4. Objectives of the study ..................................................................................................... 3
1.4.1. General objectives ........................................................................................................... 3
1.4.2. Specific objective of the study ........................................................................................ 3
1.5. Significance of the study .................................................................................................. 4
1.6. Hypothesis of the Study .................................................................................................... 4
1.7. Scope of the study ............................................................................................................ 4
1.8. Delimitation of the study ................................................................................................. 4
1.9. Organization of the Study ............................................................................................... 5
Chapter two .......................................................................................................................................... 6
2. Review of literature ............................................................................................................................ 6
2.1. Theoretical literature ...................................................................................................... 6
2.1.1. Contextual definition of External Debt ........................................................................... 6
2.1.2. Classifications of external debt ........................................................................................ 7
2.1.3. Causes of external debt ................................................................................................... 8
2.1.4. External debt and future generation ........................................................................... 11
2.2. Empirical Literature ....................................................................................................... 14
2.2.1. Related Studies in the Rest of the World ....................................................................... 14
2.2.2. Related studies in Ethiopia ............................................................................................ 15
2.3. Conceptual framework ................................................................................................. 16
CHAPTER THREE ................................................................................................................................... 18
3. METHODOLOGY OF THE STUDY ........................................................................................................ 18

3.1. The data set..................................................................................................................... 18
3.1.1. Data Type and Source ..................................................................................................... 18
3.1.2. Data Analysis ................................................................................................................... 18
3.2. Model specification ....................................................................................................... 18
3.3. Definition of variables .................................................................................................... 22
3.3.1. Dependent Variable ...................................................................................................... 22
3.3.2. Independent variable ................................................................................................... 22
3.4. Economic estimation procedures ................................................................................. 23
3.4.1. Unit Root Test .............................................................................................................. 23
3.4.2. Co-integration Test ....................................................................................................... 24
3.4.3. Error Correction Model ................................................................................................ 25
Chapter 4 ......................................................................................................................................... 26
4. Data Presentation and Analysis ..................................................................................................... 26
4.1. Descriptive Statistics .................................................................................................... 26
4.2. Empirical Analysis ........................................................................................................ 27
4.2.1. ADF Unit Root Testing Result ....................................................................................... 27
4.2.2. Co-integration .............................................................................................................. 28
4.2.3. Diagnostic Tests ............................................................................................................ 29
4.3. Model Stability Testing Result ....................................................................................... 31
4.4. Error Correction Estimation Result ............................................................................... 33
Chapter 5 ................................................................................................................................................ 37
5. CONCLUSION AND POLICY RECOMMENDATION ............................................................................ 37
5.1. CONCLUSION ................................................................................................................... 37
5.2. POLICY RECOMMENDATION .......................................................................................... 38
Reference ................................................................................................................................................ 39
Appendix ................................................................................................................................................. 41
List of tables
Table 4.1 summary of descriptive analysis………………………………………………………26
Table 4.2 Results of unit root test……………………………………………………..…………27
Table 4.3 bound testing for co-integration………………………………………………………29
Table 4.4 Tests for multicollinearity problem...............................................................................29
Table 4.5 Tests for Auto-correlation problem…………………………………………….
……...30 Table 4.6 Tests for heteroskedasticity
problem………………………………………………….30
Table 4.7 Tests for Model specification problem…………………………………….………….30
Table 4.8 Tests for Normality test problem…………………………………………….………..31
TABLE 4.9 error correction estimation result…………………………………………………..34
List of Figures
FIGURE 1: conceptual framework………………………………………………………………17
FIGURE 2: plot of cumulative sum of recursive residuals………………...…………………….32
FIGURE 3 plot of cumulative sum of squares recursive residuals………………………..……..32
List of Appendixes
Annex 1: Correlation matrix……………………………………………………………………..41
Annex 2: Descriptive Statistics………………………………..…………………………………41
Annex 3: Unit root test……………………………….......………………………………………41
Annex 4: Result of Bound Test for Co-Integration………………………………………………44
Annex 5: Diagnostic Tests…………………….…………………………………………………45
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ACRONYMS
NBE National Bank of Ethiopia
MOFED Ministry of Finance and Economic Development
WB World Bank
IMF International Monetary Fund
GDP Gross Domestic Product
OPEC Overseas Petroleum Exporting Countries
VECM Vector error correction model
ARDLM Autoregressive Distributed Lag Model
CSA Central statistical agency
LDC Least developed countries
ADF Augmented Dickey Fuller
EG Engle-Granger
AEG Augmented Engle-Granger test
CRDW Co-integration regression on Durbin Watson
USD United State Dollar
EAL Ethiopian Airline
OLS Ordinary List square

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CHAPTER ONE
1. INTRODUCTION
1.1. Background of the Study
One of the greatest problems facing many LDCs in general and Sub-Saharan Africa in particular
is highly indebtedness beyond their repayment capacities. Historically, the 1950s and 1960s are
characterized as golden year for LDCs not only owing to high economic growth, but due to
homegrown achievements. On other hand, the growth of the 1970‘s was known as debt-led due
to the fact that these countries ran a persistent current account deficit and borrowed heavily to
finance the payments gap. In 1980s things went worse, and described as lost decade by some
scholars as external debt became the nightmare of policy makers rather than their blessing
(singer, 1989). The reasons lay not only in high interest and principal needed to be paid, but such
servicing was made from ever-decreasing foreign exchange earnings from the export of goods
and services. More importantly, this decade(1980s) marked the end of non-detrimental nature of
external debts, particularly when Mexico suspended repayments of its principal in the 1982, and
ever since the issue of external debt and its service has called for critical importance and
introduced as debt-crisis into the modern economic lexicon (Befekadu, 1992). Conformed to this
general picture, the growth in sub-Saharan Africa severely declined as it also combined with
souring population growth, constantly deteriorating terms of trade, inappropriate domestic
policies and natural climates such as drought.
Ethiopia is categorized as one of the heavily indebted poor countries (HIPCs) which have been
suffering with high debt burden (WB, 2000). The debt service burden that is the amount of
foreign exchange required to repay external debt has grown enormously for the entire developing
countries is self-evident. In the case of Ethiopia, the World Bank estimates that total debt service
before debt relief has been US$464.3 million for the year 1998. This is an amount beyond the
capacity of the country to meet (Befekadu & Berhanu, 1999/2000). Between 1999/00 to 2000/01,
the debt stock increased marginally from 5,394.00 million USD to 5,479.00 million USD. And
also, during the period from 2000/01 to 2003/04, debt stock rose from 5, 479.00 million USD to
7, 367.00 million USD registering a 34 percent increase. After 2003/04, the total debt stock of
the nation decreased from 7,367.00 million USD in 2003/04 to 4.15 billion USD in 2008/09. This
huge decline in debt stock was associated with debt relief obtained as per the Enhanced – Highly
Indebted Poor Countries (HIPIC) initiative (Abinet, 2005) (Hailemariam, 2011). But after
2008/09 the debt stock and debt service shows an increasing trend due to the government
1|Page The impact of external debt on Ethiopian economic growth (2001-2021)
needing a high level of external finance as a result of exaggerated public expenditure and budget
deficit to achieve Millennium Development Goals (MDGs). That is, total debt stock increased
from 4.15 billion USD in 2008/09 to 8.87 billion USD in 2011/12.
1.2. Statement of the problem

The presence of external debt may constrain growth via two channels. First highly indebted
economy will discourage private investers from investing by expecting a higher rate of taxing
their output to repay the loan and hence results a lower level of economic growth. Second the
repayments of debt service results in pressure on the government budget and may reduce public
investment and social spending which in turn reduce economic growth (Idermit and Brain, 2005).
To many observers, debt is a new form of colonialism, different kinds of North-South relation, in
which western creditors, International Financial Institution (IFIs) and other leaders held the poor
countries in perpetual state of domination control. Communities, have holds and people’s live are
systematically destroyed using debt as a major weapon. However, to others capital movement
i.e., external debt is assumed to be a source of economic growth by stimulating investment to
those who cannot buy their own internal capital (Abinet, 2005). Inability to service debt on time
not only makes it harder for the developing countries to get aid at concessional rates with less
conditionals from the donor agencies but it also increase the countries risk (Mulugeta, 2014).
Few studies pin down the vital role of the emerging field of external debt and debt indicators in
the Ethiopian economy with emphasis on the empirical relationship of external debt and
economic growth. Mulugeta F. (2014) used data from (1983-2012) evaluated the impact of
external debt on economic growth and came up with the result that reveals past external debt
negatively affects economic growth while current external debt inflows affect it positively.
Desta (2005) used co integration and EMC approach and reported that external debt stock impact
economic growth positively. Amsalu (2017) used data from (1982-2016) and deployed vector
error correction model then found external debt stock if it is utilized optimally, would have
positive impact on economic growth but external debt servicing had crowding out effect.
Some researcher such as Hana (2013) used co integration approach and deployed only data up 10
years to 2010, and conducted external debt servicing impacted economic positively even if the
result deviated from theory of crowding out effect. Tsigereda (2017) used VECM model and

using data from (1985-2015) and concluded external debt has negative impact on economic
growth of Ethiopia.
Further, most studies lack a more comprehensive analysis that includes important variables like
labor force, and gross investment as key determinants of economic growth. Thus, by taking into
account the above gap knowledge, this paper will address the impact of debt burden on economic
growth of Ethiopia using a time series data from (2001 to 2021) using appropriate methodology.
1.4. Objectives of the study

1.4.1. General objectives
The general objective of the study is to investigate the impact of external debt on Ethiopia’s
economic growth from the period 2001 to 2021.
1.4.2. Specific objective of the study

The specific objectives of the study include the following points.
 To find out the effect of debt servicing and stock of external debt on economic growth in
Ethiopia.
 To investigate the long-run and short run relationship between external debt (debt
servicing and stock of debt) and economic growth in Ethiopia.
 To examine the macroeconomic factors that determines external debt of Ethiopia.
 To draw policy conclusions based on the findings of the study for macroeconomic
management of external debt situation
1.5. Significance of the study

Most studies in this area consider only a small number of explanatory variables in trying to
establish a statistically significant relationship between debt and growth. However, economic
theory doesn’t provide a complete specification of which variable are to be held constant when
statistical test are performed on the relation between debt and growth (Cooley and LeRoy, 2001).
One of the significance of this study is that it employs an econometric model with strong
theoretical foundations that relate external debt and economic growth. Second, provide the dearth
of empirical studies on the relationship between debt and economic growth in Ethiopia, and the
growing concern of the subject of debt, it would be useful to explore the aforementioned issues
and come up with result would help in the policy building up of the Ethiopian economy. Thus,
the outcomes of this study may be used to fill gap through analyzing the impact of external debt
burden on economic growth. The empirical findings of this study are also expected to have
insightful implication for policy.
1.6. Hypothesis of the Study

 External debt servicing has indeterminate.
 Total external debt stock has negative impact on economic growth of Ethiopia.
 Capital formation has positive impact on economic growth in Ethiopia.
 Inflation has negative impact on economic growth of Ethiopia.
 Active Labour force has indeterminate.
 Movements in real exchange rate has positive impact of economic growth of
Ethiopia.
1.7. Scope of the study

The study of this paper is covering the time period from 2001-2021. The selection of this period
is by expecting there is organized data from sources. The study as well considers only the impact
of external debt on Ethiopian economic growth.
1.8. Delimitation of the study

The results of this study can be limited by the quality of the data series available. The limitation
may be raised from the problem of inconsistency of data as represented by different institutions.
Moreover, data from the same institutions may reveal different figures for the same year. To deal
with problems, the data from single source will be used for one variable.
1.9. Organization of the Study

This study will have five chapters. The first chapter is introduction part which contains the
background, problem statement, research question, objective, hypothesis, scope, and significance
will discuss. The second chapter examines relevant literature theoretically and empirically and
also have conceptual frameworks. Chapter three focuses on methodological issues that were
reveal the method of data type and source, method of data analysis, test and distributive analysis
and the econometric model. Chapter four encompass the presentation and analysis of empirical
results obtained from the regressions result. Finally, chapter five gave conclusion and policy
recommendation

CHAPTER TWO
2. REVIEW OF LITERATURE
This section includes both theoretical, empirical review and conceptual framework, the
theoretical literature explains the theoretical aspects of external debt and its impact on economic
growth. The empirical review focused on summarizing different study related with the study.
2.1. Theoretical literature

2.1.1. Contextual definition of External Debt
According to World Bank, external debt is that part of the total debt in a country that is owed to
creditors outside the country. The debtors can be the government, corporations or private
households. The debt includes money owed to private commercial banks, other governments, or
international financial institutions.
External debt, or foreign debt as it is sometimes called, factors in both principal and interest and
does not include contingent liabilities, which are debts that may be incurred at a later date based
on the outcome of an uncertain future event. It is defined by the International Monetary Fund
(IMF) as debt liabilities owed by a resident to a nonresident, with residence being determined by
where the creditors and debtors are ordinarily located rather than their nationality. In some cases,
external debt takes the form of a tied loan, which means the funds secured through the financing
must be spent in the nation that is providing the financing. For instance, the loan might allow one
nation to buy resources it needs from the country that provided the loan.
External debt, particularly tied loans, might be set for specific purposes that are defined by the
borrower and lender. Such financial aid could be used to address humanitarian or disaster needs.
For example, if a nation faces severe famine and cannot secure emergency food through its own
resources, it might use external debt to procure food from the nation providing the tied loan.
Likewise, if a country needs to build up its energy infrastructure, it might leverage external debt
as part of an agreement to buy resources, such as the materials to construct power plants in
underserved areas.
In general, External debt is the portion of a country's debt that is borrowed from foreign lenders,
including commercial banks, governments, or international financial institutions. These loans,
including interest, must usually be paid in the currency in which the loan was made. To earn the
needed currency, the borrowing country may sell and export goods to the lending country.

2.1.2. Classifications of external debt
Classifications of external debt can be made based on different perspectives. The majors are
borrowers, creditors and productivity of the debt.
MOFED (2014) classified External debt into three based on the perspective of borrowers
1. Public Debts: These are external obligations of a national or state government. In case of
Ethiopia, all external loans contracted between external creditors and MOFED.
2. Publicly – Guarantee Debts: These are external debts where repayment is guaranteed by
a government or by an entity of the public sector in the debtor country. In case of
Ethiopia, it comprises of loans contracted by public enterprise like EEPCO, and
guaranteed by MOFED as well as the state-owned bank- the commercial bank of Ethiopia
(CBE).
3. Private – Non – Guaranteed Debts: These are external Obligations which are not
guaranteed for repayment by the government. Under Ethiopian case, it includes debt
contracted by public enterprise like EAL without government or government owned bank
guarantee.
External debt from the perspective of creditors has two major components.
1. Official Creditors: These include international organizations such as The World Bank
Group (which give multilateral loans), foreign governments and their agencies (which
give bilateral loans). Loans from these two sources usually come on ―sift‖ and
concessionary terms and have relatively longer-term maturity and low rates of interest.
2. Private Creditors: These include contractors, exporters, manufacturers or other suppliers
of goods and services hence there are contractor finance and supplier of credit.
Debts are also classified into two based on the uses they are put into:
1. Reproductive debt: this is raised for productive purposes and is used to add to the
productive capacity of the economy. These loans are utilized on development activities
like infrastructure development like roadways, railways, airports, power generation,
telecommunications etc. it is self - liquidating in nature, this means the principal amount
and interest are normally paid out of the revenue generated from the projects to which the
loans were utilized.

2. Dead weight debt: An unproductive debt is one which does not yield any income. It does
not add to the productive assets of the country. Debts utilized to finance war and
expenses on current expenditures
2.1.3. Causes of external debt

The following are some causes for external debt especially in sub-Saharan Africa. Those are A.
Corruption and the mismanagement of resources by some leaders.
One of the most worrying causes of debt in Africa has been corruption and mismanagement of
resources.
B. Borrowing at high-interest rates to service debts
Borrowing to pay debts is one of the most disturbing causes of debt. This business of borrowing
to pay debt is known as the debt trap. Debt trap is indeed the vicious circle of taking international
or domestic loans to service a county’s debts. For most sub-sahran African countries, the reality
of high and rapidly increasing interest rates in the 1970s and 1980s had reached heights that were
simply unsustainable for their comparatively weak economies. This situation resulted in high
levels of default which compelled most of them to resort to borrowing in order to service their
loan payment obligations.
C. The oil price shocks and crisis
The Yom Kippur War of 1973 between Israel and a coalition of Egypt and Syria resulted in sharp
increases in oil prices globally from $ 3.00 to $12.00 per barrel. The Overseas Petroleum
Exporting Countries (OPEC) exploited the dependency of the western nations on oil, to boost the
political power on the international arena
A second oil shock occurred in 1979, caused by the outbreak of the first Gulf War between Iran
and Iraq. This war resulted in huge losses in the production, storage and distribution of oil that
pushed the prices of oil from $ 12 in 1973 to $ 39 per barrel in 1979. This sharp and
unanticipated increase pushed most non-oil producing African countries into debt, because it
forced them into the debt trap of borrowing to meet the oil consumption requirements.

D. Declining revenue from the export of African primary commodities
For African countries whose incomes depended largely on the export of raw materials, natural
disaster, declining rainfall and unpredictability of prices worryingly increased their vulnerability
to debt. They have witnessed a worrying decline of about 50% in the prices for the export of their
primary exports commodities in the last 25 years.
In the case of coffee and sugar, this was due to overproduction and saturation of the markets.
Because of the unequal status within the international trade system, African countries have
suffered tremendous losses as a result of the ‘terms of trade’. The capitalist international system
of division of labour has assigned African countries the role of producers and suppliers of raw
materials (like cocoa, coffee, rubber, cotton, sugar cane, timber etc) whose prices have been
falling steadily as compared to the prices of manufactured goods.
E. Aid Dependency syndrome
The Aid dependency syndrome may well have contributed to the indebtedness of African
countries and their growing poverty levels. Aid can be classified into three main types:
1. Humanitarian or emergency aid:- given in response to natural disasters like fire, flood
or to earthquake victims
2. Charity-based aid:- which normally comes from non-profit organizations and
foundations countries hit by drought, famine, war, displaced people or refugees
3. Systematic multi-lateral aid: - which comes from the World Bank, Overseas
Development Agency.
Unfortunately the systematic aid packages have often failed in achieving their goals of providing
infrastructure, fighting poverty, disease, illiteracy and hunger, and building capacity for good
governance in Africa. Across the world, recipients of aid have become worse off. Aid has helped
to make the poor poorer and made growth slower because of the dependency syndrome trap.
Sixty years of three trillion dollars development aid to Third World countries, has little evidence
of significant effect on recipients in fighting poverty, disease, hunger, illiteracy, unemployment
and environmental degradation.

Western countries engaged with African countries depending on what benefits are at stake.
Western donor countries often turned a blink-eye on corruption and gross human rights abuses in
countries they depended on for their much-needed raw materials. Systematic aid was used as bait
in dealing with and winning the friendship of corrupt leaders in Africa, whose dealings with
donors have further worsened the debt profile of African countries.
F. Rising cost of imports for African countries
The rising cost of imports is another disturbing cause of debt to African countries. The rising cost
of imports like medicine, machinery, equipment, arms and ammunitions and other consumables
coupled with the decreasing export earnings of African countries has worsened the level of
indebtedness resulting in what has become known as the triangle of disaster – youth
unemployment, rural poverty and environmental degradation.
G. Changes in the International Capital Market
A major cause of the African debt problem was the oil boom and the changes it provoked on the
international capital market. The sharp and steady increase in the price of oil resulted in OPEC
amassing ‘petrol-dollars’ in private banks in search of investment opportunities. Most African
countries took advantage of these ‘petrol-dollars’ by taking more loans to undertake heavy
infrastructural projects. These loans which they did not have the capacity to service, eventually
increased their levels of indebtedness to the lending institutions.
Furthermore, the existence of the ‘petrol-dollars’ weakened the power of the industrialized
western countries to match the flow of funds to Africa with the capacity to pay; a function that
was traditionally played by the World Bank and the IMF. This lack of control provided African
countries the freedom of taking loans they were not in the position to service.
Finally, the deterioration of the Soviet-Union, the structure of development assistance to Africa
also changed. Industrialized countries diversified their aid to meet new demands from the former
Soviet-Union Bloc states in Africa.

H. Rises in Interest Rates
The extensive and excessive armament activities of the Ronald Reagan Administration couple
with a tax-reduction policy in the US, induced investment recovery and change in the operating
procedures of the Federal Reserve’s monetary policy with tighter restraints that led to a sharp
increase in real interest rates and the value of the dollar. This development had a very devastating
effect on African countries interest payment and import bills.
2.1.4. External debt and future generation

What is the effect of debt burden (servicing) on macroeconomic performances and future
generations? In general, there are five views providing different submissions can be identified.
Those are:
2.1.4.1. The neo-classical model

This model assumes that individuals plan their consumption decision over the entire life cycle.
Borrowing increases present consumption and thereby shifts tax burden to the future generations.
This school of thought assumes full employment implying that increase in consumption
decreases savings, causing interest rates to increase in the capital markets to restore the
equilibrium. The higher interest rates in turn results in a decline in private investment. This
crowding out effect impedes the effectiveness of the government to influence the economy
through fiscal policies (Bailey, 1971; Buiter, 1977). The weakness of this theory is that very few
economies especially in Sub- Saharan Africa, including Kenya have not achieved even near full
employment level.
2.1.4.2. The Keynesian model

This model brings forth a counter proposition by pointing out the multiplier effects of external
debt (Eisner, 1989). It suggests that increased external borrowing results in an increase in
domestic production, which boosts investor sentiments about the future path of the economy.
Moreover, borrowing implies investment in infrastructure, which could lead to a reduction in the
cost of doing business in future and hence benefits future generation. Keynesians also permit less
than full employment of resources and consequently, the government has to intervene in order to
assure that demand is sufficiently large so that labor demand rises; national income rises and
approaches its full employment level. In addition, according to that view public debt does not
pose a problem if the government runs into debt in the home country. They further argued that
10 | P a g e The impact of external debt on Ethiopian economic growth (2001-2021)

debt finance was necessary to ensure an adequate level of aggregate demand because savings
cannot be fully absorbed by private investments. In addition, the Keynesians took up the position
originally held by Ricardo that the burden of public debt is completely shouldered by the
generation that issues the debt. This view can be summarized by the phrase we owe the public
debt to ourselves.
‘‘Government budget deficits and hence rising government debt do not, therefore, pose particular
problems: they are not harmful, and they are desirable in times of low aggregate demand and
high unemployment to restore the full-employment equilibrium.
2.1.4.3. The Ricardian Equivalence theory

According to this theorem, the society‘s burden from the government spending is brought about
by the wastage use rather the source of financing the expenditure. Therefore, it does not matter
how the funds are raised through taxation or by borrowing loans. If the current expenditure is
financed through borrowing, this reduces the amount of taxes to be paid by the current
generation. Future taxation will be much higher to repay, this means that the disposable income
in future will reduce (Contessi, 2012). 14 The burden of tax is postponed rather than being
reduced. If the population is aware that the tax burden will increase in future, they are more
likely to increase the level of consumption but not save or make an investment that is equivalent
to the amount of reduced tax. Government debt is seen as an equivalent to future taxes since
there is no crowding effect of capital and consumption by the population and hence debt neutral
to growth. National government may finance its expenditures through taxes or issuance of bonds.
Bonds in this case are loans; this is repaid by raising adequate taxes in future. The decision is
therefore tax now or later. For instance, if the government finances extra spending through
deficits that is borrowing now to pay later, the tax payers will prospect of having to pay higher
taxes in the future. This will lead to an increase in their savings to make pay for future tax which
in turn mitigate their current consumption, however, the effect on the aggregate demand will be
the same if the government was to choose tax now (Cameron and Trivedi, 2005).this theory as
advanced by Barro (1974) argues that increase in borrowing must be paid for, either now or later.
Therefore, a reduction in current taxes must be matched by an increase in future tax burden to
repay the debts, leaving interest rates and consequently private investments essentially
equivalent. Government finance is therefore irrelevant (Ricardo, 1942). However, this model is

critical due to the planning horizon of individuals which is not long enough, an assumption in
this model.
2.1.4.4. Modigliani model

This model claims that either future or current generation may bear the burden of external debt
based on the purpose borrowed money put for. The future generation certainly bears a burden if
the money borrowed is used to finance current consumption because its consumption level is
reduced by an amount equal to the loan plus the accrued interest that must be sent to foreign
lenders (Modigliani, 1961). If, on the other hand, the loan is used to finance capital
accumulation, the outcome depends on the project‘s productivity. If the marginal return on the
investment is greater than the marginal cost of funds obtained abroad, the combination of the
debt and capital expenditure actually makes the future generation better off. To the extent that the
project‘s return is less than the marginal cost, the future generation is worse off. Tax burden
might be offset in part, totally or more than the offset if there is an increase in debt, which leads
to an increase in the public expenditure that leads to an increase in the real income of the future
generation through channels such as gainful public investments and productity (Modigliani,
1961).
2.1.4.5. Intergenerational model

Two models categorized under this are overlapping generation and Lerner models. The former
model defines a generation as everyone who was born at about the same time. Hence at any
given time several generations coexist simultaneously. The model assumes no private savings
(everyone consumes their entire income) and the situation is expected to continue forever. In this
model, the population consists of equal number of the young, middle-aged and old people. The
burden of a debt can be transferred across generations; the old age passes the burden to the
middle-aged and the middle-aged to the young. The internal external debt distinction that is vital
in Lerner‘s model is irrelevant here; even though the debt is all internal, it creates a burden for
the future generation. By comparing the net taxes paid by different generations, one can get a
sense of how government policy redistributes income across generations. The overlapping
generation‘s model does not allow for the possibility that individuals in a given generation may
care about their descendants as well as themselves. This intergenerational model discussed do not
allow for the fact that economic decisions can be affected by government debt policy, and
changes in these decisions have consequences for who bears the burden of the debt. Instead, it is

assumed that the taxes levied to pay off the debt affect neither work nor savings behavior. If
taxes distort these decisions, real costs are imposed on the economy. More importantly, they
ignore the potentially important effect of debt finance on capital formation.
2.2. Empirical Literature

A number of research related to the external debt impact on economic growth have been done
both in Ethiopia at country level and outside it at international level. The result from the studies
showed both positive and negative effects of external debt on economic growth. Some of these
studies are stated at both case:
2.2.1. Related Studies in the Rest of the World

Tokunbo (2006) studied how the use of budget deficits as an instrument of stabilization leads to
the accumulation of external debt with the attending effects on growth in Nigeria between 1970
and 2003.By synthesizing a relationship between budget deficits and external debt the study
shows the implications on economic growth of conducting a fiscal policy within the contexts of
debt stabilization and debt sustainability.
Michael & Sulaiman (2012) in Nigeria examined the impact of external debt on economic growth
and investment by adopting the debt Cum-Growth model along with multiple regression
technique. From the results, they conclude that there was existence of a positive relationship
between external debt, economic growth and investment.
Utomi O. (2014) studied the impact of external debt on economic growth in Nigeria for period
1980-2012 using time series data on external debt stock and external debt service to capture
fordebt burden both in the long run and short run. The study used techniques including
augmented dickey fuller (ADF), Test for johasen integration, VECM AND GCT. The results
showed statistically insignificant long run relationship and bidirectional relationship between
external debt and economic growth in the Nigeria.
Kangara (2015) investigated the effect of national debt on economic growth of Kenya using data
from 2005-2014 .The study employed a regression model, descriptive statistics and correlation
analysis to analyze the data. The conclusions of the study reveal that a national debt is negatively
related to economic growth in Kenya –which implies the increase in national debt negatively
impacted the economy of the country. The results indicated that net exports and consumption

contributed positively to GDP; however, an increase in national debt, interest rates and inflation
are found to have negative effect on GDP.
2.2.2. Related studies in Ethiopia

Befekad (1992) studied the impact of foreign debt on economic growth of Ethiopia using the data
from1964-1984, and found that long-term external debt has had a positive impact on the
economy. While in the pre-revolution period and the early post-revolution years the relationship
is positive, it turned negative during the post-revolution era. However, the post-revolution
performance cannot be attributed to foreign debt. Rather, the problem was one of inappropriate
domestic policies. The regime's policy of curtailing private-sector economic activity, coupled
with its own, not only limited, but grossly inefficient utilization of resources, failed to take full
advantage of the existing infrastructure. The lesson one draws from the Ethiopian experience is
that while external factors could be contributory, major responsibility seems to lie in domestic
factors. The main stumbling block in the Ethiopian case is found to be the policy of the
government.
Hana Argaw (2013) investigated the impact of external debt on economic growth of Ethiopia
employing macroeconomic model estimated for 2000-2010.The empirical findings reveal that
external debt does not have effective on economic growth. The result indicated that both debt
service payment and foreign exchange reserve have positive relationship with growth gross
domestic product of the country, rather than depressing it and hence the study confirms that there
is no sign of debt overhang which negatively affects economic growth of country.
Mulugeta (2014) empirically studied the impact of external debt on economic growth in Ethiopia
to determine the existence of a debt overhang and/or crowding out effects using time series data
for the period 1983/84 to 2012/13. The Johansen Maximum Likelihood approach was used to test
for a long-run relationship among the variables and Vector error correction model (VECM) used
to estimate the short run impacts. The empirical result suggests the existence of long run
relationship between real GDP and external debt. The results of the study reveal that real GDP is
influenced negatively by the past stock of external debt and debt servicing and, positively by the
current external debt inflows. This was indicating the existence of debt overhang problem and
crowding out effect in Ethiopian economy.

Wessene (2014) examined the long run and short run relationship between external debt and
economic growth in Ethiopia over the period of 1970/71-2010/2011 using Autoregressive
Distributed Lag Model (ARDLM) or bound testing approach. The empirical results indicated that
the relationship between external debt and economic growth both in the short run and long run is
significant with a negative sign. This indicates the existence of a debt overhang problem in the
country. But the debt servicing variable has a negative but insignificant effect on economic
growth. Moreover, there exists unidirectional causality from external debt to economic growth.
Therefore, external debt is found to have a negative effect rather than causing economic growth
in Ethiopia for the period under study. Hence, in order to tackle the problems of external debt,
there should be close monitoring and consistent debt management strategies so as to avoid the
misallocation and mismanagement of external debt.
To conclude the theoretical and empirical Literature, there are several contextual definition,
according to World Bank external debt is defined that part of the total debt in a country that is
owed to creditors outside the country. The classifications of external debt can be made based on
different perspectives like MOFED (2014) classified External debt into three based on the
perspective of borrowers those are public debt, Publicly – Guarantee Debts and Private – Non –
Guaranteed Debts. External debt also have impact on future generation which discussed above
with 5 different views. Further, Empirical studies on determining external debt on Ethiopian
economic growth shows negative sign to GDP. However, external debt servicing has negative
impact but some studies show it has positive impact to GDP. Economic growth as reviewed the
above literature is determined by debt indicators (stock of external debt and external debt
servicing), inflation, exchange rate and foreign aid.
2.3. Conceptual framework

In this conceptual framework, indicates the relationship of dependent variable and independent
variable. The dependent and independent variable relationship has been developed based on the
above theoretical and empirical literature review.

FIGURE 1: CONCEPTUAL FRAME WORK
Crowding out effect Debt overhang effect
Debt servicing Stock of debt
Debt Indicators
Real gross domestic product
Inflation Real gross capital Active labour force

Movement of real
exchange rate
formation
To know macro
economic condition
Source: own construction (by taking the theoretical and empirical review)

CHAPTER THREE
3. METHODOLOGY OF THE STUDY

This section provides a blueprint for directing a research and outlines framework to investigation
the impact of debt on economic growth of Ethiopia in a given time period. In particular the
chapter provides technical approaches that the researcher adopted in model selection to answer
the research questions and to meet the objectives. The chapter basically focuses on how the entire
study will be done. Issue such as data types and sources, definition of variables, model
specification, and estimation procedures and techniques are covered.
3.1. The data set

3.1.1. Data Type and Source
The type of data which is applicable for the study is time series which are secondary in their
nature. An attempt that will gather 20 years data on some important variables. The data covers
the period between 2001 and 2021. These data are obtained from different sources: such as
World Bank (WB) and central statistical agency (CSA). The debt indicator (like stock of external
debt and debt servicing) data will draw from national bank of Ethiopia (NBE) and the data (like
real gross capital formation, Labor force, real exchange rate and inflation) will be gather from
World Bank (WB).
3.1.2. Data Analysis

The data analysis and estimation will employ both descriptive analysis and an econometric model
which employ ordinary least square (OLS) multiple regression models. To estimate the model
and to examine the statically significance of the explanatory variables, time series data were
employed from 2001 to 2021. The statistical software package uses the econometric analysis will
be STATA 14 and EVIEWS10.
3.2. Model specification

Conceptually, model specification refers to the determination of which independent variables
should be included in or excluded from a regression equation. This study is based on augmented
Harrod-Domar and dual gap model as the latter is an extension of the former one. The H-D

growth model provides the simplest possible framework within which the relationships among
the aggregate macro variables can be examined.
The basic H-D model can be summarized as follow:

Yt = Ct + St…………………………………………. (4.1)
Where; Yt = GDP, Ct = Consumption and St = saving
Equilibrium in the simple economy requires It = St; thus, equation (4.1) changes to
Yt = Ct + It …………………………………….. (4.2)
Within the Harrod Domar framework the growth of real GDP is assumed to be proportional to the
share of investment spending (I) in GDP and for an economy to grow, net additions to the capital
stock are required. The evolution of capital stock overtime is given as
K t+1 = (1 –σ)Kt + It …………………………..(4.3)
Where; Ϭ is the rate of depreciation of the capital stock. The relationship between the size of the
total capital stock(K) and total GDP(Y) is determined as the capital output ratio (K/Y, it also
follows that V= ∆K/∆Y where ∆K/∆Y is the incremental capital output ratio, or ICOR). If we
assume that total new investment is determined by total savings and total saving is some
proportion of GDP (St= sYt), then the essence of the H-D model can be set out as follows, since
K = VY and It = St, it follows that we can rewrite equation (4.3) As:
VYt +1 =(1-σ)vYt + sYt………………………….(4.4)
Yt +1 – Yt = (S/V-Ϭ)Yt…………………………..(4.5)
(Yt+1 – Yt)/Yt = (S/V-Ϭ)………………………… (4.6)
Where,( Yt+1 – Yt)/Yt is growth rate of GDP and substituting it by G then,
G= S/V –Ϭ…………………………….………. (4.7)
Depreciation (Ϭ) is considered to be constant and can be ignored, so
G=S/V…………………………………………… (4.8)

The model shows that output and capital formation are linearly related. That is, when there is
more capital stock, the higher would be the growth of economy. From the outset, the Horrar
Domar model was used to calculate the amount of finance required to bridge the gap between the
available savings and the required amounts that must be channeled to investment to bring about
the targeted growth rate (Easterly,1998). This implies, in the H-D model, constraints on savings
is the binding limit to growth. That is, when domestic savings alone are inadequate to bring about
the investment level necessary to attain the targeted growth rate, then growth is said to be
constrained by the saving gap. The role of foreign finance, which includes external debt, in this
regard is to augment domestic saving rates to achieve the targeted growth.
Dual gap includes the gap between the import and export as well in addition to saving gaps as
other factor limiting growth. This approach is based on the assumption that all investment goods
are not produced locally. That is, some level of capital import is necessary in order to achieve the
desired investment level. When foreign exchange earned through export are insufficient, actual
import will be lower than the level required achieving a targeted growth rate. Thus, the role of
foreign inflow here is to finance the import bill left uncovered through export earnings so as to
achieve the targeted growth rate. This approach got emphasis since developing countries depend
on imported capital goods and intermediate inputs. In this model, both gaps represent
independent limit to growth where inflow of foreign fund is used to fill gaps (Chenery and
Strout, 1966) The model is coined from a national income accounting identity which states that
excess investment expenditure over domestic saving is equivalent to the surplus of imports over
exports.
Thus, at equilibrium the following identities held;
I – S = M – X …………………………………… (4.9)
S – M = X – M ………………………………….. (4.10)
Where, I= investment, S= saving, M=import, X= export
The equations (4.9 and 4.10) show that the domestic resource gap(S-I) is equal to foreign
exchange gap(X-M). An excess of import over export implies an excess of resource used by an
economy over resources generated by it. This further implies that the need for foreign borrowing
is determined overtime by the state of investment in relation to domestic savings.

Following the above theoretical relationship of foreign borrowing and economic growth,
Can be augmented with debt indicator as

Yt = F(EDGDP, DSR)……………………………(4.11)
Where, EDGDP = stock of external debt to GDP ratio, DSR= the debt service as ratio of export
Earnings. These variables represent external debt indicators of the nation. However, the level of
capital formation alone does not guarantee growth as postulated by the H-D model.
The empirical model is specified on the basis of the theoretical model explained above part
taking into account other variables that are believed to be important in describing the model
better in the context of the country under study, Ethiopia. Moreover, the model is preferred based
on its relevance and availability of data. The original model is borrowed from Elbadawi et al
(1996) studies on the debt burden and production function after making adjustment to reflect
Ethiopian conditions. The model will apply OLS estimation method because of its convenience
and simplicity.
Therefore, the mathematical regression equation is:
RGDP = F(EDGDP, DSR, RER, INV, INFL, LLFP)
Then the econometric equation is formulated as follows:
RGDPt = β0 + β1EDGDPt + β2DSRt + β3INVt + β4INFLt + β5RERt + β6LLFPt + Ut
Where, β0, β1 … β6are parameters to be estimate the model.
RGDPt = Real Gross Domestic Product
EDGDPt = Stock of external debt to GDP ratio
DSRt = the debt service as a ratio of export earning
INVt = Real gross capital formation
INFLt = Rate of inflation (reflects macro-economic stability)
RERt = Movements in real exchange rate
LLFPt = Active labor force as percentage of total population Ut = the error term

3.3. Definition of variables
3.3.1. Dependent Variable
 Real gross domestic product (RGDP) is used as a proxy variable to measure economic
growth in the country. It is represented by the country‘s total output at constant price per
birr.
3.3.2. Independent variable

 Total external debt stock is used as percentage of GDP. It indicates the impact of
external debt on the economy and it measures the indebtedness of the country in the given
period of time. External debt does not necessarily imply slower economic growth, rather
if only the country became unable to meet its external debt obligations that it would pose
a risk to economic prosperity and leads to debt overhang (Shabbir, 2013). Therefore, we
also expect that β1 will be negative.
 Total debt service, the sum of both principal and interest payment. It is also used as
percentage of export of goods and service. It shows the debt burden of the country and
tries to capture the crowding out effect. The debt crowding out effect is also studied by
different researchers like Krugman (1988) and sachs (1989). This is the case when
indebted poor countries transfer resources, including foreign aid and foreign exchange
resources to service their accumulated debt. The equivalent ratio which can trap the
crowding out effect is the total debt service export ratio. The study expects a negative
impact of the ratio on economic growth (WB, 2010). The empirical findings result
indicated that both debt service payment and foreign exchange reserve have positive
relationship with growth gross domestic product of the country (Hana Argaw, 2013)
Therefore, the expect sign of β2 will be indeterminate.
 Capital Formation: Capital means the stock of physical reproducible factors of
production. When the capital stock increases with the passage of time it forms capital. An
increase in the rate of capital formation raises the level of national income. The process of
capital formation helps in raising national output which in turn raises the rate and level of
national income. Elizabeth et al (2011) investigated that capital formations has a

significant positive impact on economic growth. Therefore, the expected relationship
between GDP and capital formation will be positive or the sign of β3 will be positive
 Inflation: measures how much more expensive a set of goods and services has become
over a certain period, usually a year. Due to inflation, GDP increases and does not
actually reflect the true growth in an economy. This is why the GDP must be divided by
the inflation rate to get the growth of the real GDP. Thus, between GDP and inflation
rate, a reverse statistical correlation exists. As the inflation ratio is higher, the value of
GDP in real terms decrease. We also expect that β4 will be negative.
 Exchange rate: is how much of one currency can be bought for each unit of another
currency. A currency appreciates if it takes more of another currency to buy it, and
depreciate if it takes less of another currency to buy it. The exchange rate is one of the
important factors that influence the GDP of the economy. Exchange rate and foreign
currency exchange reserves are highly correlated which influence the GDP a lot
(pramanik, subhajit, 2021). Therefore, the expected sign of β5 will be positive.
 Active Labour force: or currently active population, comprises all persons who fulfil the
requirements for inclusion among employed (civilian employment plus the armed force)
or the unemployed. Additionally, holding productivity per worker constant, an increase in
the share of adults who are working through a rise in the labour force participation rate
will directly increase GDP per capita. However, some arguments indicate that labor force
of LDCs negatively affects growth due to unskillfulness and inefficiency of them
(Todaro, 1994). This might be true for Ethiopia, and hence it is difficult to predetermine
the expected sign.
3.4. Economic estimation procedures

For any given time, data output serve for policy recommendation from derived concussion and it
is mandatory to pass via three stages estimation of techniques. Each of which of any or other way
tests the stationary of time series variable. The commuting of error in each stage cannot permit
progress into the next stage unless the data are adjusted in away to fulfill criteria of that
particular stages of estimation techniques requires.

3.4.1. Unit Root Test
The data is checked whether it is stationary or not before conducting any economic study. If the
variables under study are non-stationary, then may leads to spurious result so it is important that
the series of data is stationary. That is its mean and variances are constant that over times and the
value of covariance between two time periods and not on the actual time at which covariance is
computed (Gujarati D.N, 2004). In time series econometric time series has a unit root is known
as random walk time series (Green, 1990). A random walk is an example of non-stationary time
series. Augmented Dickey Fuller (ADF and) Phillips Peron (PP) tests are the two ways of
checking unit root tests. For passing decision whether a given data is stationary or not compared
ADF with the computed absolute value of “t” statistics i.e., if “t” statistics or calculated exceeds
“t” critical or tabulated, we can reject the null hypothesis that says unit root is exist or non-
stationary meaning we can say that unit root is not exist then the series is stationary. But if “t”
calculated is less than
“t” tabulated we cannot reject the null hypothesis and then the series is stationary. The formula of
this ADF test is as follows
∆RGDPt=β0+β1RGDPt- +εi …………………. ADF Stationarity
Phillips and Peron also use non parametric statistical methods to take care of the serial
correlation in the error terms without adding lagged difference terms.
3.4.2. Co-integration Test

After checking for unit root tests, the test of co-integration can be performed. Co-integration test
tells about whether there is long term relationship between the variables or not. The pre-request
of applying this test is to first check for unit root so that it is decide whether the series is
stationary or not. To find out RGDPt= β0 if two or more-time series are co-integrated, Gujarati
put two methods: Engle-Granger (EG) or Augmented Engle-Granger (AEG) test and co-
integration regression on Durbin Watson (CRDW) tests. In regarding to the decision rule, the
same rule DF or ADF unit root test is applied to EG or AEG test. Accordingly, if the calculated
“t” value in absolute value exceeds the EG 1%, 5%, and 10% critical value, then the time series
variables are co-integrated. This test is formulated as follows
RGDPt + εi …………………………. Long run Co-integration

Where, εi=error term, β0……. βi = parameters, Xi =explanatory variables in the model Finally,
the model becomes:
RGDPt = β0 + β1EDGDPt + β2DSRt + β3INVt + β4INFLt + β5RERt + β6LLFPt + εi
From this model regression predict the residual term (ECM) which is subject to unit root analysis
and find that it is stationary; that is it is I(0).
3.4.3. Error Correction Model

The error correction mechanism is a means of reconciling the short run behavior of an
econometric variable with its long run behavior. It is believed that economic variables are co-
integrated when they establish along run equilibrium relationship between variables involved.
But there may be exist disequilibrium in the short run. Therefore, in this case one treats the errors
term of regression equation as the “equilibrium error” and this error term can be used to smooth
the short run behavior of a given time series variable to its long run behavior.
DRGDPt + αECM_1+ei ………………. short run
Even though those pre-estimation tests are mandatory, we also undertake some post-estimation
tests including, multicollinearity test, Heteroscedasticity, normality test, and auto correlation test
to make our findings more robust.

CHAPTER 4
4. DATA PRESENTATION AND ANALYSIS

This chapter focused on the results of the study that the researchers investigated both in the
longrun and short-run. The analysis used descriptive and inferential statistics. Descriptive
statistics like mean, standard deviations, minimum value, maximum value, and standard
deviation and table used. Inferential statistics applied using ARDL model test co-integration by
error correction bound test, VECM, diagnosis test and sensitivity tests are conducted.
4.1. Descriptive Statistics

Before estimating the data, it's important to describe the properties and the behavior of the study
variables. It is useful to take some corrective measures so that the variables are certainly
applicable for the estimation process. The result given in the table below describes some
behavior of the variables.
variables observations mean median Std. dev. minimum maximum
RGDP 21 96.04555 82.62810 57.41999 1.3456 219.9289
EDGDP 21 35.73571 29.58602 21.8989 10.51625 84.43963
DSR 21 12.35528 8.062594 8.445988 2.793224 28.53743
INV 21 351361.4 164525.7 380913.6 18468.05 1216585
INFL 21 3.560193 3.269115 1.326016 0.8216381 6.660082
LLFP 21 85.56754 85.62743 0.4335067 84.88136 86.15302
Table 4.1 summary of descriptive analysis
From table 4.1, the real gross domestic product had a mean 96.04555 and standard deviation
57.41999 with the maximum value 219.9289 and minimum value 1.3456. The Stock of external
debt to GDP ratio under the study had a mean of 35.73571 and the standard deviation of 21.8989
with a minimum and maximum of 10.51625 and 84.43963 respectively. The debt service as a
ratio of export earning had a mean of 12.35528 and a standard deviation of 8.445988 with the
minimum value of 2.793224 and a maximum value of 28.53743 for the period under study. Rate
of inflation had a mean of 3.560193 and a standard deviation of 1.326016 with a minimum of -
0.8216381 and a maximum of 6.660082. Gross capital formation had a mean of 351361.4 and a
standard deviation of 380913.6 with a minimum and maximum value of 18468.05 and 1216585

respectively. Finally, the mean of Active labour force was 85.56754 and a standard deviation of
0.4335067 with the minimum value of 84.88136 and a maximum value of 86.15302 for the
period under study.
The standard deviation shows how much dispersion exists from the average value. Except gross
capital formation a low standard deviation indicates that the data point tend to be very close to
the mean, whereas gross capital formation has high standard deviation indicates that the data
point are spread out over a large range of values. As shown in the summary statistics, all have
low standard deviation (except gross capital formation). This shows stability in the long run
relationship between real gross domestic product and its determinant factors.
4.2. Empirical Analysis

4.2.1. ADF Unit Root Testing Result
Before conducting the simultaneous tests, the variables must be found to be individually
stationary. The augmented Dickey Fuller (ADF) test is applied here to determine the existence of
a unit root test. This test is basically has been used for its consistency, accuracy and
resourcefulness. The table below shows the result of ADF test of variables under consideration at
level.
VARIABLES ADF t-statistic in level AFD t-statistic in First Unit root
Difference
Intercept Intercept and Intercept Intercept and
trend trend
RGDP -2.612565 -2.766952 -5.971664* -6.256782* 1

EDGDP -6.471501* -5.634289* -2.880077*** -2.830689 0
DSR -0.846366 -3.764037** -4.612071* -3.940409** 1
INV 5.491701 1.138665 0.538865 -9.088484* 0
INFL -3.348221** -3.555507*** -5.199070* -4.987180* 0
LLFP -1.685980 -6.893717* -3.016040*** -1.779153 1
* 1% 0 stationary at level
** 5% 1 stationary at first difference
*** 10%
Table 4.2 Results of unit root test

As shown in the table above, augmented Dickey-Fuller and tests the variables Stock of external
debt to GDP ratio (EDGDP), real gross capital formation (INV) and Rate of inflation (INFL) are
stationary at level. Whereas, = Real Gross Domestic Product (RGDP), the debt service as a ratio
of export earnings (DSR) and Active Labor force as percentage of total population (LLFP) are
stationary at first difference. This implies the series are mixed order for the given time series, the
ARDL methodology is quite appropriate to be adopted. This gives the stepping stone for the next
co-integration analysis and error correction estimation that may proceed to the existence of
cointegration
4.2.2. Co-integration
Co-integration is the formal statistical justification of the existence of this relationship among the
variables for the long-run equilibrium. Hence, after determining the stationary nature of the
variables, the next task in the bounds test approach of co-integration is estimating the specified
ARDL model using the appropriate lag-length selection criterion. According to Pesaran and
Shine (1999), as cited in Narayan (2004)for the annual data, they recommended choosing a
maximum of two lag lengths but for small data, it is advisable to use 1 lag because when the lag
length increases, the observation fail to show the appropriate long run relationship among
variables. Accordingly, under the study period, co-integration (a long run relationship) is
witnessed between real gross domestic product and the given set of determinants considered and
shown as follows:
Pesaran/Shin/Smith (2001) ARDL Bounds Test
H0: no levels relationship
Test Statistic Values K
F-statistic 6.108 5
T-statistic -5.612 5
Critical Value Bounds for F-statistic
Significance I0 Bounds I1 bounds
10% 2.26 3.35
5% 2.62 3.79
2.5% 2.96 4.18
1% 3.41 4.68
Critical Value Bounds for T-statistic
Significance I0 Bounds I1 bounds
10% -2.57 -3.86

5% -2.86 -4.19
2.5% -3.13 -4.46
1% -3.43 -4.79
Table 4.3 BOUND TESTING FOR CO-INTEGRATION
From the above table, the F-statistics value (6.108) is greater than I1 series at a 1% level of
significance. Then, we can’t reject null hypothesis. That means there is co-integration. And the
Tstatistics value (-5.612) is below I1 series at a 1% level of significance. Therefore, there is
cointegration or long-run relationship among the variables. Thus, the bound test shows there is
cointegration among the variables. In other words, there is a systematic relationship that
functionalizes the variables to form a linear stationary process that adjusts to the long-run after
any shocks or deviation of the short-run.
4.2.3. Diagnostic Tests

4.2.3.1. Multicollinearity test
It refers to when explanatory variables are highly interrelated. Variance inflation factor can be
employed to detect this problem. For this study it is tested both at level and after transforming the
variables by taking first difference for each variable. Table shows the results of VIF
VARIABLES EDGDP DSR Gross Capital Labour force Inflation
VIF 2.51 7.77 6.20 6.08 1.53
1/VIF 0.398115 0.128675 0.161388 0.164400 0.654690
Mean VIF 4.82
Table 4.4 Tests for multicollinearity problem
The data has no multicollinearity problem as mean of VIF is 4.82 which is far less than 10
4.2.3.2. Auto-correlation test

This assumption states that; disturbance terms is that the covariance between the error terms over
time (or cross-sectionally, for that type of data) is zero. In other words, it is assumed that the
errors are uncorrelated with one another. Autocorrelation test is conducted by applying Durbin-
Watson Test (d-statistics) and Breusch-Godfrey Serial Correlation LM Test. The area in which
we do not reject null hypothesis and decide that we do not have autocorrelation problem in the
model is if the Durbin Watson value is located between 4-dL and 4-dU.The differenced
regression result of the model shows, Durbin Watson statistics value is 2.190106 which is clearly
located between dU and 4-dU. Therefore, based on the result there is no autocorrelation. The BG

test (at 2 lags) which is shown in the below table clearly presents the absence of autocorrelation
hence null hypothesis cannot be rejected even at 10% critical value.
lags(p) chi2 df Prob > chi2

2 1.864 2 0.3938
H0: no serial correlation
Table 4.5 Tests for Auto-correlation problem
4.2.3.3. Heteroskedasticity test

It is assumed that the variance of the errors is constant, σ2 this is known as the assumption of
homoscedasticity. If the errors do not have a constant variance, they are said to be
Heteroscedasticity. The study uses Breusch-Pagan-Godfreytest for Heteroscedasticity. The null
hypothesis of this test is homoscedasticity or constant variance. With the level of significant 5%,
the p-value should be greater than 5% to conclude that there is no Heteroscedasticity problem.
Breusch-Pagan / Cook-Weisberg test for heteroskedasticity
Ho: Constant variance

Variables: fitted values of RGDP
chi2(1) = 0.74
Prob > chi2 = 0.3894
Table 4.6 Tests for heteroskedasticity problem
Above result there is no heteroskedasticity in the data since Chi is relatively small and p-value is
greater than critical at 5% level.
4.2.3.4. Model specification test

Model specification test is a way of detecting whether there is model specification bias or not due to
irrelevant variables, omitting relevant variables or adopting wrong functional form etc. Ramsey has proposed
a general test of specification error called RESET (regression specification error test) and it is applied here.
Ramsey RESET test using powers of the fitted values of RGDP
Ho: model has no omitted variables

F(3, 12) = 0.96
Prob > F = 0.4428
Table 4.7 Tests for Model specification problem

Taking the p-value 0.4428 greater than 5%, we can’t reject the null hypothesis of there is no
omitted variable in the model. Hence, the model is correctly specified.
4.2.3.5. Normality test

This is to test whether data is normal distributed or not, and Skewness and kurtosis normality test
is used for this purpose. Ho: the data is normally distributed
Variable obs Pr(Skewness) Pr(Kurtosis) adj chi2(2) Prob>chi2
RGDP 21 0.4613 0.9913 0.57 0.7525
EDGDP 21 0.0175 0.4009 5.92 0.0518
DSR 21 0.2607 0.0522 4.98 0.0828
Inflation 21 0.3514 0.3463 1.95 0.3767
Gross Capital 21 0.0475 0.9836 4.16 0.1249
Labour force 21 0.6983 0.0827 3.57 0.1681
Table 4.8 Tests for Normality test problem
The null hypothesis cannot be rejected for all variable at 5% level, and hence all are normally
distributed.
4.3. Model Stability Testing Result

After the entire short-run and long-run estimation, model or parameters stability is tested.
Commonly, the stability of the model for long run and short run relationship is detected by using
the cumulative sum of recursive residuals (CUSUM) and cumulative sum of squares of recursive
residuals (CUSUMSQ). Cumulative sum of recursive residuals (CUSUM) helps as to show if
coefficients of the parameters are changing systematically and the cumulative sum of squares of
recursive residuals (CUSUMSQ) tests is useful to indicate if the coefficient of regression are
changing suddenly. We accept the null hypothesis of the parameter instability if the blue line
cross redline which is critical line and never returns back between two critical line and we reject
the null and accept the alternative there is parameter stability in the short run and long run if the
cumulative sum goes inside the area (can returns back) between the two critical lines.

FIGURE 2: PLOT OF CUMULATIVE SUM OF RECURSIVE RESIDUALS
CUSUM lower
upper
CUSUM
0 0
2008 2021
year
Source: own computation using STATA14
FIGURE 3 PLOT OF CUMULATIVE SUM OF SQUARES RECURSIVE RESIDUALS

CUSUM squared
CUSUM squared 1
2008 2021
year

4.4. Error Correction Estimation Result
After confirming the existence of long-run co-integration relationship among the variables, the
next step is running the appropriate ARDL model to find out the long-run and short-run
coefficients. Hence, error correction model estimation for both the short-run and long-run
coefficients simultaneously presented in table below. Besides, the model passes all the post
estimation diagnostics tests including the normality, heteroscedasticity, serial correlation, model
specification, and model stability. In addition, the estimation results show that the estimated
model has good fit (R2 = 0.9965). The coefficient estimate for the error correction term is the
lagged dependent variable and the short-run dynamics are captured by the first differenced
variables while the long run is captured by level variables in the error correction model.
VARIABLES ADJ LR SR
RGDP -.2440369***
(0.1565048)
EDGDP -7.374097***
(0.4616049)
DSR 2.141406*
(0.8414179)
INV 0.0000909**
(0.0000241)
LLFP 1.80695***
(0.7639338)
INFL -15.63014***
(0.9257269)
D.EDGDP -8.920132***
(0.8042764)
D.DSR 2.067396
(2.459648)
D.INV -0.0004643**
(0.0001364)
D.LLFP -1.559369
(0.7523388)
_cons -6.566168***
(0.4759623)
F( 14, 4) = 80.75
Prob > F = 0.0003
R-squared = 0.9965
Adj R-squared = 0.9841
Log likelihood = -49.106672
Root MSE = 6.9915
*** p < 0.01, ** p < * p < 0.1
0.05,
TABLE 4.9 ERROR CORRECTION ESTIMATION RESULT
Table 4.9 revealed the speed of adjustment to restore equilibrium in the dynamic model. The
ECM coefficient demonstrates how variables quickly approach to equilibrium; in fact, it is
theoretically expected to have a negative and statistical significance coefficient. The model have
negative signs, as expected and confirms the existence of co-integration among variables at 1%
level of significance. Furthermore, a high statistical significance error correction term confirms
that the variables have stable long-run relationship. The error correction coefficient ECM-1 is -
0.244. This indicates that the deviation in the short-run equilibrium narrows to the long-run
equilibrium at a speed of 24.4 percent per year. The constant has a negative significant
coefficient of 6.566168 with a P- value of 0.001 hence in our case significant at 1% confidence
level. The estimated results show that R2 and adjusted R2 of 0.9965 and 0.9841 respectively. This
signifies that 99.65 percent of the variations in real gross domestic product is explained by the
independent variables. High value of R 2 indicated that the independent variables (Stock of
external debt to GDP ratio, the debt service as a ratio of export earning, Real gross capital
formation, Rate of inflation and Active
Labor force as percentage of total population) succeed to Real Gross Domestic Product
Long run result

According with previous empirical studies in Ethiopia, on macroeconomic side, most of the
explanatory variables have their expected signs in the long run. In this study, the estimation
result reveals that the Real gross capital formation and Labor force as percentage of total
population are found to have a positive and significant effect on to Real Gross Domestic Product
in the long run whereas Stock of external debt to GDP ratio and Rate of inflation is found to have
a negative and significant effect.
Impact Stock of external debt to GDP of on Real GDP
It is implied that Stock of external debt to GDP had a negative contribution to economic growth
of Ethiopia and the result is significant at 1% level of significance. The coefficient of EDGDP is
7.374097 indicating that a one unit increase in the stock of debt will result in -7.374097 percent
decline in real gross domestic product. This indicates the existence of debt overhang problem in
the country. This implies that government with a heavy debt burden is forced to increase taxes in
the future in order to service high debt burden. Then, after-tax return on capital will be reduced
due to the rise in tax. As a result, the incentive to invest will be lowered. Thus, the decline in
investment results in slow economic growth (Krugman, 1987). This result is consistent with the
findings of Melese (2004) for Ethiopia, Wessene Kassa(2014) for Ethiopia , Muluget
Fekadu(2014), Kangara (2015) for Kenya and Elbadawi, et al(1996) for Sub Saharan countries.
Impact of the debt service as a ratio of export earning to RGDP
The debt service as a ratio of export earning had a positive contribution to economic growth of
Ethiopia and the result is significant at 10% level of significance. The coefficient of DSR is
2.141406 indicating that a one unit increase in the debt service will result in 2.141406 percent
increase in real gross domestic product. This result indicates the absence of debt overhang in the
long run period in the economy.
Impact of Real gross capital formation on Real GDP
The variable real investment (INV) which is used as a proxy variable to measure capital in the
economy had significantly positively affect RGDP in the long run. This shows that capital
influences output as it is included as an input in production and plays a major role in enhancing
growth which is consistent with the standard growth theory. The coefficient of INV is 0.0000909
indicating one percent increase in real investment as share of GDP induces 0.0000909 percent

increment in output and the result is significant at 5%. This result agrees with the result of studies
by Wessene Kassa(2014) for case of Ethiopia ,and Were (2001) for the case of Kenya.
The impact of Rate of inflation on Real GDP
Rate of inflation had a negative contribution to economic growth of Ethiopia and the result is
significant at 1% level of significance. The coefficient of INFL is -15.63014 indicating that a one
unit increase in rate of inflation will result in -15.63014 percent decline in real gross domestic
product. This result is consistent with the findings of Kristine et al. (2011). The reason is
inflation reduces investment because people could expend their money to survive than invest,
which in turn narrow the gap of saving-investment. Therefore, inflation will have negative effect
on RGDP in the future.
The impact of Active Labor force
The other variable is Active Labor force as share of total population has positive and significant
effect on economic growth of the country. The coefficient is 1.80695 which shows one unit in
labor force results in 1.80695 percent increase in output and significance in 1%. This is due to
the fact that labor is one factor of production whose increases enhances economic growth.
Short run result

The long run and short run coefficients of the model are found to be similarly related in except
for Stock of external debt to GDP ratio which is positively related in long run and the opposite in
short run.
The coefficient of real gross capital formation is -0.0004643 indicating one percent increase in
real investment as share of GDP and the result is significant at 5% level of significance. The
coefficient of EDGDP is -8.920132 indicating that a one unit increase in the stock of debt will
result in 8.920132 percent decline in real gross domestic product and at 1% level of significance.
The other important variable is Active Labor force has the coefficient of -1.559369 which shows
one unit in labor force results in -1.559369 percent decrease in output and affect insignificantly.
The other rest of are insignificant as shown in the above table.
CHAPTER 5

5. CONCLUSION AND POLICY RECOMMENDATION
5.1. CONCLUSION
A developing economy needs to tap all possible resources to mobilize required financial
resources for the implementation of its developmental programs. External debt is one of the
essential tools which supplement the internal financial resources particularly in developing
economies where the existence of severe shortage of capital is a common observance. However,
the heavy reliance on external debt for resource gap results in debt burden problem that is
reflected in the form of rising level of external debt stock and debt servicing. Therefore, wise and
proper utilization of foreign debt by investing in selective and productive investment and
increasing the domestic saving are the main concern.
The central focus of this study is examining the short run and long run impact of external debt on
economic growth in Ethiopia for the period 2001 to 2021. The study used Harrod- domar models
as a foundation for the empirical study. The OLS was used for the empirical analysis of short run
and long run relationship of external debt and economic growth. ADF test was used to check for
stationarity in the data, and all variables became stationary after first difference except Active
Labor force, real gross capital formation and real gross domestic product. The diagnostic tests
including multicollinearity, autocorrelation, hetroskedasticity, model specification, normality and
co-integration tests were applied and data passed all these tests.
The empirical analysis attempted to investigate the long run and short run relationship of external
debt and economic growth used growth equation which was originally borrowed from Elbawi
(1996).The equation was real gross domestic product as a function of real domestic investment,
total labor force as share of total population, total external debt as percentage of GDP, debt
service as percentage of export, inflation rate and real exchange rate. Both long run and short run
empirical results were consistent and revealed that both real investment and labor force as share
of total population have a positive significant relationship with economic growth which is in line
with conventional economic theories. On other hand, external debt stock as percentage of GDP
was found to have a negative significant relationship with economic growth. This implies high
external debt lower economic growth and evidences the existence of debt overhang problem in
Ethiopia.

The other debt burden indicator variable debt service export ratio has shown a significant positive
relationship with economic growth. However, this relationship is unexpected since theoretically
debt services erodes and diverts resources that could be used for investment and growth to debt
repayments and thereby lowers foreign reserve of the country. In case of Ethiopia this was not
evidenced owing to the existence of huge debt relief, debt rescheduling and forgiveness that
prevents the appearance of crowd out effect. The other variable is inflation. This variable has
negatively significant nexus with economic growth in long run.
5.2. POLICY RECOMMENDATION

Based on the results found, the following policy recommendations are to be forwarded.
 External debt ought to be utilized properly and wisely by being invested on prioritized
and most productive investment such as basic infrastructure that also facilitate the
productivity of other sector of the economy.
 The borrowed fund should be channeled to the productive real sectors of the economy
rather than social consumption. Furthermore, the duration of debt profile should match
the nature of investment it is needed to finance so as to obviate debt maturity before
earnings from investments financed with it
 The government should focus on investment activities since it found to have positive
effect on economy. They should also play important roles in stimulating the economy and
encourage domestic saving. Thus, in long run foreign savings will only supplement rather
than replacing domestic savings.
 The country should introduce effective debt management as a major policy concern in
order to obviate the misutilization and mismanagement of debt. This will also avoid
wastages and mismatches in debt utilization.
 External debt should only be contracted when it is really needed to finance projects or
investments that will significantly contribute for the growth and development of the
economy.

 Another implication of this analysis is that policies that encourage domestic investments,
foreign direct investment and increased trade earnings and thereby effect GDP growth
and reduce dependence on external debt for development should be enforced.

Reference
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growth in Nigeria,‖ The macro theme Review 4(8), special issue iv, Multidisciplinary journal of
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cointegration analysis”, Economic Society monographs, 371-413
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paper, College of development studies, Covenant University
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Empirical Assessment”, UNU-WIDER Research Paper, DP2001/116

Appendix
Annex 1: Correlation matrix
RGDPsq EDGDP DSR GrossC~l labour~r inflat~t exrate
RGDPsq 1.0000
EDGDP -0.4087 1.0000
DSR -0.4784 0.0102 1.0000
GrossCapital -0.4240 -0.2764 0.8575 1.0000
labourforc~r 0.7090 -0.2674 -0.8663 -0.7221 1.0000
inflations~t 0.0698 -0.5401 0.0091 0.2493 0.0624 1.0000
exrate -0.3962 -0.3103 0.7734 0.9785 -0.6976 0.3029 1.0000
Source: own computation using STATA14 Annex
2: Descriptive Statistics
. summarize RGDPsq EDGDP DSR GrossCapital labourforcewinsor inflationsqrt
Variable Obs Mean Std. Dev. Min Max
RGDPsq 21 96.04555 57.41999 1.3456 219.9289

EDGDP 21 35.73571 21.8989 10.51625 84.43963
DSR 21 12.35528 8.445988 2.793224 28.53743
GrossCapital 21 351361.4 380913.6 18468.05 1216585
labourforc~r 21 85.56754 .4335065 84.88136 86.15301
inflations~t 21 3.560193 1.326016 .8216381 6.660082

Source: own computation using STATA14 Annex
3: Unit root test
Null Hypothesis: RGDP has a unit root

Exogenous: Constant
Lag Length: 0 (Automatic - based on SIC, maxlag=2)
t-Statistic
Prob.*
-2.612565
Augmented Dickey -Fuller test statistic 0.1070
Test critical values: 1% level -3.808546
5% level -3.020686
10% level -2.650413
Null Hypothesis: RGDP_SQ has a unit root

Exogenous: Constant, Linear Trend

t-Statistic
Prob.*
Augmented Di ckey-Fuller test statistic -2.766952
0.2237 Test critical values: 1% level -4.498307
5% level -3.658446
10% level -3.268973
Null Hypothesis: EDGDP has a unit root

Exogenous: Constant
t-Statistic
Prob.*
-6.471501
5% level -3.040391
10% level -2.660551
Null Hypothesis: EDGDP has a unit root

t-Statistic
Prob.*
-5.634289
5% level -3.690814
10% level -3.286909
Null Hypothesis: DSR has a unit root

Exogenous: Constant
t-Statistic
Prob.*
Augmented Dickey -Fuller test statistic -0.846366 0.7835

5% level -3.020686
10% level -2.650413
Null Hypothesis: DSR has a unit root

t-Statistic
Prob.*
-3.764037
5% level -3.658446
10% level -3.268973
Null Hypothesis: GROSS_CAPITAL has a unit root

Exogenous: Constant
t-Statistic
Prob.*
5.491701
5% level -3.029970
10% level -2.655194
Null Hypothesis: GROSS_CAPITAL has a unit root

t-Statistic
Prob.*
1.138665
5% level -3.673616
10% level -3.277364

Null Hypothesis: INFLATION_SQRT has a unit root
Exogenous: Constant
t-Statistic
Prob.*
-3.348221
5% level -3.020686
10% level -2.650413
Null Hypothesis: INFLATION_SQRT has a unit root

t-Statistic
Prob.*
-3.555507
5% level -3.658446
10% level -3.268973
Null Hypothesis: LABOUR_FORCE_WINSOR has a unit root

Exogenous: Constant
t-Statistic Prob.*
Augmented Dickey -Fuller test statistic -1.685980 0.4219

5% level -3.029970
10% level -2.655194
Null Hypothesis: LABOUR_FORCE_WINSOR has a unit root

t-Statistic Prob.*


5% level -3.658446
10% level -3.268973
Source: own computation by Eviews10
. matrix list e(lags)
e(lags)[1,6]
RGDPsq EDGDP DSR GrossCapital labourforc~r inflations~t r1
1 2 2 2 2 0 Source: own
computation using STATA14
Annex 4: Result of Bound Test for Co-Integration
Pesaran/Shin/Smith (2001) ARDL Bounds Test

H0: no levels relationship F = 6.108
t = -5.612 Critical Values (0.1-0.01), F-statistic,
Case 3
[I_0] [I_1] [I_0] [I_1] [I_0] [I_1] [I_0] [I_1]
L_1 L_1 L_05 L_05 L_025 L_025 L_01 L_01
k_5 2.26 3.35 2.62 3.79 2.96 4.18 3.41 4.68

accept if F < critical value for I(0) regressors reject
if F > critical value for I(1) regressors Critical
Values (0.1-0.01), t-statistic, Case 3
[I_0] [I_1] [I_0] [I_1] [I_0] [I_1] [I_0] [I_1]
L_1 L_1 L_05 L_05 L_025 L_025 L_01 L_01
k_5 -2.57 -3.86 -2.86 -4.19 -3.13 -4.46 -3.43 -4.79

accept if t > critical value for I(0) regressors reject
if t < critical value for I(1) regressors
k: # of non-deterministic regressors in long-run relationship Critical

values from Pesaran/Shin/Smith (2001)
.
Annex 5: Diagnostic Tests

1. heteroskedasticity
. estat hettest
Breusch-Pagan / Cook-Weisberg test for heteroskedasticity

Ho: Constant variance
Variables: fitted values of RGDPsq
chi2(1) = 0.74
Prob > chi2 = 0.3894

2. Model specification test
. estat ovtest
Ramsey RESET test using powers of the fitted values of RGDPsq

Ho: model has no omitted variables
F(3, 12) = 0.96
Prob > F = 0.4428
3. Multicollinearity test
. estat vif
Variable VIF 1/VIF
DSR 7.77 0.128675

GrossCapital 6.20 0.161388
labourforc~r 6.08 0.164400
EDGDP 2.51 0.398115
inflations~t 1.53 0.654690
Mean VIF 4.82

4. Auto-correlation test
. estat bgodfrey, lags(2)
Breusch-Godfrey LM test for autocorrelation

lags(p) chi2 df Prob > chi2
2 1.864 2 0.3938
H0: no serial correlation
. estat dwatson
Durbin-Watson d-statistic( 6, 21) = 2.190106
5 Normality test

Skewness/Kurtosis tests for Normality
joint
Variable Obs Pr(Skewness) Pr(Kurtosis) adj chi2(2) Prob>chi2
RGDPsq 21 0.4613 0.9913 0.57 0.7525

EDGDP 21 0.0175 0.4009 5.92 0.0518
DSR 21 0.2607 0.0522 4.98 0.0828
GrossCapital 21 0.0475 0.9836 4.16 0.1249
labourforc~r 21 0.6983 0.0827 3.57 0.1681
inflations~t 21 0.3514 0.3463 1.95 0.3767

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WOLKITE UNIVERSITY

COLLEGE OF BUSSINESS AND ECONOMICS

IMPACT OF EXTERNAL DEBT ON ETHIOPIA ECONOMIC GROWTH

A Research Submitted to the Department of Economics School of Graduate

ADVISOR: Dr. ABDULAZIZ A

Signed by Board of examiners:

Examiner: ______________________; Signature: _________________; Date:

Examiner: ______________________; Signature: _________________; Date:

Advisor: _______________________; Signature: _________________; Date:

List of tables ............................................................................................................................................. iv

3. METHODOLOGY OF THE STUDY ........................................................................................................ 18

Table 4.3 bound testing for co-integration………………………………………………………29

Table 4.4 Tests for multicollinearity problem...............................................................................29

Table 4.5 Tests for Auto-correlation problem…………………………………………….

……...30 Table 4.6 Tests for heteroskedasticity

Table 4.7 Tests for Model specification problem…………………………………….………….30

Table 4.8 Tests for Normality test problem…………………………………………….………..31

TABLE 4.9 error correction estimation result…………………………………………………..34

FIGURE 2: plot of cumulative sum of recursive residuals………………...…………………….32

FIGURE 3 plot of cumulative sum of squares recursive residuals………………………..……..32

Annex 2: Descriptive Statistics………………………………..…………………………………41

Annex 3: Unit root test……………………………….......………………………………………41

Annex 4: Result of Bound Test for Co-Integration………………………………………………44

Annex 5: Diagnostic Tests…………………….…………………………………………………45

MOFED Ministry of Finance and Economic Development

IMF International Monetary Fund

GDP Gross Domestic Product

OPEC Overseas Petroleum Exporting Countries

VECM Vector error correction model

ARDLM Autoregressive Distributed Lag Model

CSA Central statistical agency

LDC Least developed countries

ADF Augmented Dickey Fuller

AEG Augmented Engle-Granger test

CRDW Co-integration regression on Durbin Watson

USD United State Dollar

EAL Ethiopian Airline

OLS Ordinary List square

1.2. Statement of the problem

2|Page The impact of external debt on Ethiopian economic growth (2001-2021)

1.4. Objectives of the study

1.4.2. Specific objective of the study

1.5. Significance of the study

1.6. Hypothesis of the Study

1.7. Scope of the study

1.8. Delimitation of the study

1.9. Organization of the Study

4|Page The impact of external debt on Ethiopian economic growth (2001-2021)

2.1. Theoretical literature

5|Page The impact of external debt on Ethiopian economic growth (2001-2021)

6|Page The impact of external debt on Ethiopian economic growth (2001-2021)

2.1.3. Causes of external debt

Corruption and the mismanagement of resources by some leaders.

B. Borrowing at high-interest rates to service debts

C. The oil price shocks and crisis

7|Page The impact of external debt on Ethiopian economic growth (2001-2021)

E. Aid Dependency syndrome

8|Page The impact of external debt on Ethiopian economic growth (2001-2021)

F. Rising cost of imports for African countries

Examiner: ______; Signature: _; Date:

Examiner: ______; Signature: _; Date:

Advisor: _______; Signature: _; Date: