Assessing the Short- and Long-run Real Effects of Public External Debt: The Case of Tunisia

Abstract

This study examines the effects of external debt on the economic growth of Tunisia both in the short run and the long run. We specify a growth equation based on the standard neoclassical growth model that we extend by adding public external debt indicators and some control variables. Annual time series data was gathered from 1970 to 2010. The Engel and Granger (1987) econometric techniques are employed in the empirical analysis in order to regress an error correction model (ECM) which allows estimating the short- and long-run consequences of debt on the Tunisian economic growth. The main results of this analysis can be summarized as follows: (1) Although the ratio of public external debt to GDP is relatively low in this country, the levels of external debt achieved are growth-damaging. We estimate that, on average, a 1 percentage point increase in the ratio of public external debt reduced annual growth rate by 0.15-0.17 percentage points. The impact is much higher in the long run in the sense that the long-run level of GDP per capita decreases by 0.27 per cent as this ratio increases by 1 per cent. (2) Our results also identified the existence, for Tunisia, of a threshold for the impact of external debt, which is evidence in agreement with the 'debt overhang' phenomenon. This threshold is estimated to around 30 per cent of GDP. (3) The traditional 'crowding-out effect' associated with service and interest payments of debt as well as the 'resources-diversion effect' associated with the extent of corruption in this country have been put forward in this analysis as two possible transmission channels of the detrimental consequences of external debt. (4) Finally, Tunisia will need to implement drastic policy changes that reduce fiscal deficit in order to prevent further deterioration. © 2014 African Development Bank.