External debt relief initiatives and economicgrowth in least developed countries

In the late 1990s, the World Bank and the International Monetary Fund (IMF) initiated a series of debt relief programs for highly indebted poor countries (HIPCs) based on the idea that high levels of indebtedness impede growth by discouraging domestic and foreign investment. This paper examines the relationship between external debt and growth with a focus on the effects of multilateral debt relief. In particular, we use a sample of 33 least developed countries (LDCs) over the period 1970-2010 to explore the impact of indebtedness on growth before and after participating in the debt relief initiatives. In contrast to previous studies, we employ a combination of parametric and non-parametric methods to investigate the linear and nonlinear aspects of the debt-growth relationship. In the non-parametric analysis, we model growth as a discreet-time Markov process and estimate the transition probabilities for HIPCs. The results show that lower debt levels stimulate economic growth. The average impact of debt on growth in HIPCs becomes negative at about 64 -78% of GDP depending on the initial growth conditions. In the period after joining the debt relief initiatives, HIPCs generally exhibited a higher chance of moving towards or persisting in the positive range of growth. However, this process was related to lower debt levels mostly in countries that had initially exhibited moderate to rapid growth, while debt relief seems to have been less relevant for future growth in countries that started off in a state of moderate economic decline. Furthermore, the results of the regression analysis show that the marginal effect of public and publicly guaranteed (PPG) debt on growth is negative and significant. Debt relief programs were found to mitigate the negative impact of debt, both after their initiation in 1996 and after the HIPCs reached their decision point. Generally, the overarching policy that can be drawn from this paper is that LDCs, and HIPCs in particular, should strive to reduce their PPG debt levels to at least below 64%-78% of GDP in order to experience and maintain positive growth rates, ceteris paribus. Notwithstanding, our findings also suggest that if HIPCs, and LDCs in general, want to reduce or maintain their debt to sustainable levels, they should adopt some of the conditions imposed by the international financial institutions on HIPCs as part of their macroeconomic policy framework, such as developing and implementing a poverty reduction strategy through a broad based participatory process.