The University of Zambia
School of Business
AN ANALYSIS OF THE EFFECTS OF PUBLIC
DEBT ON ECONOMIC
GROWTH: THE CASE OF ZAMBIA: 2011 – 2021
Table of Contents
CHAPTER ONE: ....................................................................................................................... 1
INTRODUCTION ..................................................................................................................... 1
1.1 Introduction .......................................................................................................................... 1
1.2 Background of the study ...................................................................................................... 1
1.3 Statement of the problem ..................................................................................................... 3
1.4 Research objectives .............................................................................................................. 3
1.4.1 General objective.......................................................................................................... 3
1.4.2 Specific objectives........................................................................................................ 3
1.5 Research hypothesis ............................................................................................................. 4
1.6 Significance of the study...................................................................................................... 4
1.7 Scope of the study ................................................................................................................ 4
1.8 Limitations of the study ....................................................................................................... 5
1.9 Definition of key terms ........................................................................................................ 5
1.10 Dissertation layout ............................................................................................................. 5
1.11 Chapter summary ............................................................................................................... 6
CHAPTER TWO: ...................................................................................................................... 7
LITREATURE REVIEW .......................................................................................................... 7
2.1 Introduction .......................................................................................................................... 7
2.2 Empirical review .................................................................................................................. 7
2.2.1 Global perspective ........................................................................................................ 7
2.2.2 Regional perspective .................................................................................................. 11
2.2.3 Local perspective........................................................................................................ 16
2.3 Theoretical framework ....................................................................................................... 17
2.3.1 The debt overhang theory........................................................................................... 17
2.3.2 The dual gap theory .................................................................................................... 18
2.4 Conceptual framework ....................................................................................................... 18
2.5 Gaps in literature ................................................................................................................ 19
2.6 Chapter Summary .............................................................................................................. 20
CHAPTER THREE: ................................................................................................................ 21
METHODOLOGY .................................................................................................................. 21
3.1 Introduction ........................................................................................................................ 21
3.2 Research approach ............................................................................................................. 21
3.3 Research design ................................................................................................................. 21
3.4 Model specification ............................................................................................................ 21
3.5 Priori expectation ............................................................................................................... 22
3.6 Sample size ........................................................................................................................ 22
3.7 Data sources ....................................................................................................................... 22
3.8 Data estimation techniques and techniques procedures ..................................................... 23
3.9 Diagnostic tests .................................................................................................................. 23
3.9.1 Autocorrelation Test................................................................................................... 23
3.9.2 Heteroscedasticity Test .............................................................................................. 24
3.9.3 Normality Test............................................................................................................ 24
3.9.4 Model Stability Test ................................................................................................... 24
3.10 Research validity and reliability ...................................................................................... 24
3.11 Ethical Considerations ..................................................................................................... 25
3.12 Chapter summary ............................................................................................................. 25
REFERENCES ........................................................................................................................ 26
CHAPTER ONE:
INTRODUCTION
1.1 Introduction
When a countries revenue falls short of its expenditure, they ask their governments to borrow.
External debt is a tool for a government to access funds for public spending, particularly where
there is difficulty to raise taxes and reduce expenditure. Over the years this process of
borrowing funds has left most governments with massive outstanding debts. Reasonable
borrowing used to finance infrastructure development are very key to fast economic growth
though excess borrowing without planning appropriately for investment may lead to heavy debt
burden and interest payment, which may create several undesirable effects for the economy
(Joy and Panda, 2020). This section represents the background of the study, statement of the
problem, objectives of the study, research hypothesis, and significance of the study, scope of
the study as well as operational key terms/concepts.
1.2 Background of the study
One of the key macro-economic objectives of the Zambian government from independence till
date is the achievement of sustainable economic growth. To achieve this goal, the government
requires a substantial amount of capital finance through investment expenditures on
infrastructural and productive capacity (Umaru et al, 2013). Consequently, this facilitates the
growth of gross domestic product (GDP), which if persistent should culminate in economic
development, a status vigorously pursued by all less developed countries (LDCs). However,
the amount of capital available in most developing countries, Zambia inclusively is grossly
inadequate to meet economic growth needs mainly due to low productivity, low savings and
high consumption pattern (Musaba, 2013). The Zambian government therefore resorts to
borrowing from outside the country to bridge the resource gap. The motive behind this by the
Zambian government is to promote economic growth and development by creating a conducive
environment for people to invest in various sectors of the economy (Mwale, 2017). The other
reasons for borrowing include: to finance the deficit budget, to finance a huge capital project,
to provide employment opportunities, emergency, and so on.
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Substantial economic growth is a major concern for any sovereign nation especially the LDCs
which are characterized by low capital formation due to low savings and investment (David
2019). It is expected that least developed countries when facing a scarcity of capital would
resort to borrowing from public sources so as to supplement domestic savings. It is widely
recognized in the international community that excessive foreign indebtedness in most
developing countries is a major impediment to their economic growth and stability (Fuso
2019). Developing countries like Zambia have often contracted large amounts of public debt
that has led to the mounting of trade debt arrears at highly concessional interest rates. Gohar
and Butt (2014) opined that accumulated debt service payments creates a lot of problems for
developing nations reason being that a debt is actually serviced for more than the amount it
was acquired and this slows down the growth process in such nations. The inability of the
Zambian economy to meet its debt service payments obligations has resulted in debt overhang
or debt service burden that has militated against her growth and development (Musaba, 2019).
Public borrowing has a significant impact on the growth and investment of a nation up to a
point where high levels of public debt servicing sets in and affects the growth and focus moves
from financing private investment to repayments of debts. (Fosu, 2019) observed that high debt
service payments shift spending away from health, education and social sectors. This obscures
the motive behind public borrowing which is to boost growth and development rather than get
drowned in a pool of debt service payments which eats up most of the nation’s resources and
hinders growth due to high interest payments on public debt.
Zambia as a developing nation has adopted a number of policies such as the structural
adjustment Programme (SAP) of 1992 to liberalize her economy and boost gross domestic
product (GDP). In a bid to ensure the implementation of these policies the government
embarked on massive borrowings from multilateral sources which resulted in a high public
debt burden. By 2000, Zambia’s public expenditure was around 33% of gross domestic product
(GDP) and its external debt was U$6.3 billion. In the same year, Zambia reached the decision
point under enhanced heavily indebted poor country (HIPC) initiative which resulted in
substantial debt relief. As of end of June 2019 as reported by the minister of finance Dr Bwalya
Ng’andu. Zambia’s public debt stood at a whooping figure of U$26.44 billion. Zambia remains
one of the largest debtors in Sub- Sahara African region and its resultant effects has created
some unfavorable circumstances such as crowding out of private investment, poor GDP
growth, high exchange rates, high inflation rates to mention but a few.
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1.3 Statement of the problem
It has been argued that external debt affects economic growth of any country either in a positive
or negative way (David, 2019). Zambia like most highly indebted poor countries has low
economic growth and low per capita income with insufficient domestic savings. The country
has undertaken various developmental projects with the aim of improving the welfare of its
citizens and promoting economic growth and development. However, to finance these projects,
the country has to acquire extra funds in the form of debt to ensure that they are all achieved.
Ever since Zambia’s independence in 1964, there has been an accumulation of debts aimed at
various developmental projects without obvious results as expected (Chewe, 2019). It is no
exaggeration that this is a major challenge faced by the Zambian economy.
As at end-June 2021, Zambia’s total public debt was $26.44 billion excluding interest arrears,
and $26.96 billion including interest arrears with little to no economic growth.(mof.gov.zm).
Over the past few years Zambia has been seeking a bailout from IMF and a staff level approval
granted (David, 2021) this has led to the removal of subsidies and has had an effect on public
and private investments. Although there is substantial literature on the impact of external debt
on economic growth, most of these have employed cross country studies, which have been
criticized for ignoring the heterogeneity among economies (Savides, 2014). Developing
countries differ significantly in terms of their economic and political environment, organization
and institutions, hence the need for specific country study to ascertain the association between
these variables. In the case of Zambia external debt over the period of analysis depicts a rising
trend and therefore, the country is not precluded from the implication of a rising debt stock and
this has necessitated the need for an empirical analysis of the above phenomenon in Zambia.
1.4 Research objectives
1.4.1 General objective
To investigate the impact of public debt on economic growth in Zambia from 2011-2021
1.4.2 Specific objectives
i.
To assess the effect of external public debt on economic growth in Zambia.
ii.
To evaluate the effect of domestic public debt on economic growth in Zambia
iii.
To establish the relationship between exchange rates and economic growth in Zambia
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1.5 Research hypothesis
i.
H0: External debt has no impact on economic growth in Zambia.
H1: External debt has an impact on economic growth in Zambia.
ii.
H0: Internal Public debt has no impact on economic growth in Zambia.
H1: Internal Public debt has an impact on economic growth in Zambia.
iii.
H0: Exchange rates have no impact on economic growth in Zambia.
H1: Exchange rates have an impact on economic growth in Zambia.
1.6 Significance of the study
The study is inspired by the fact that a lot of literature on the matter has focused mainly on
cross sectional analysis on a number of countries. Furthermore, a number of recent studies on
external debt have concentrated on those countries included in the HIPC initiative. If the
intention is to analyse the overall relationship between external debt and growth then such
concentration would lead to bias, hence the need to also assess the external debt implications
on economic growth for non HIPC countries like Zambia. On the other hand, adequate
knowledge and understanding of the effects of heavy external debt burden on an economy will
inform macroeconomic policy formulation geared towards minimizing macroeconomic
imbalances and elimination of economic distortions caused by heavy external debt obligations.
The rationale of this research is to investigate the effects public debt has on economic growth
in Zambia. This study is significant as its findings will provide a basis which will aid policy
makers in proffering polices aimed at managing the debt crisis situation in Zambia.
1.7 Scope of the study
This study seeks to analyse Zambia’s public debt and its impact on her economic growth. In
order to fully capture its effect on the economy, a thorough empirical investigation will be
conducted with time series data covering from 2011 to 2021.
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1.8 Limitations of the study
Constraints such as time, delays by central statistics office in releasing the information required
for the research maybe encountered in the course of the study
1.9 Definition of key terms
Public debt: This is the total amount of money borrowed by a government of a country
(Marvin, 2019).
Economic development: This is the creation of wealth from which community benefits are
realized (Todaro, 2004)
Public debt service repayments: This is the amount of money used in the interest and
principal of the public debt.
Economic growth: This is the rate of expansion in the volume of production of goods and
services in an economy (Marvin, 2019).
Fiscal deficit: A situation where government expenditure exceeds income generated
(International Monetary Fund, 2000)
Exchange rate: The value of one currency for the purpose of conversion to another (Mulyoto,
2013).
Exchange rate: This is a relative price of one currency expressed in terms of another currency
(or group of currencies) (Marvin, 2019).
1.10 Dissertation layout
Chapter one sets the tone of the study by providing the background, problem, objectives,
questions, scope, significance and limitations of the study. Chapter two presents a review of
literature relevant to the study, wherein a theoretical review, an empirical review and a
conceptual framework are highlighted. Chapter three presents the methodology that was used
when carrying out the study. The research philosophy, approach, strategy, techniques and
procedures are discussed. Chapter four has the findings of the study analysed and discussed.
Chapter five gives the conclusions derived from the findings, and recommendations are given
to that effect.
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1.11 Chapter summary
This chapter has given an overview of the research. It has outlined the background of the study,
the statement of the problem, the objectives as well as the questions arising from those
objectives and the hypotheses. The chapter has also discussed the scope of the study as well as
the definition of key term. The next chapter (Literature Review) focuses on available literature,
journals and other useful materials in this study.
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CHAPTER TWO:
LITREATURE REVIEW
2.1 Introduction
This chapter reviews theoretical literature on public debt on economic growth. It gives an
insight of what other researchers have found to have been some contributing factors.
2.2 Empirical review
This section discusses studies that have been done before in relation to the subject matter under
investigation. The studies have been categorized into global, regional and local perspectives.
2.2.1 Global perspective
Empirical studies relating to the impact of debt on economic growth have recently gained
ground. There has been a growing number of studies devoted to this issue in developing
countries, especially since the debt crisis in the 1980s.
At Country level, some of the studies reviewed in this area also showed consistent results to
theory despite applying different methodology techniques. For instance, Syed et al (2010)
employed OLS to analyse public debt and economic growth in Pakistan for a period 1972 to
2010. The study did allude to poor social economic conditions arising mainly due to huge
public debt which stands to be over the GDP figure in Pakistan. The results in this study
were in support of the neoclassical theoretical arguments on debt accumulation.
Calderon and Fuentes (2013) using a panel framework investigated the relationship between
debt and growth in Latin America countries over the period 1970 to 2010. The study revealed
that debt has a negative impact on economic growth. Notably, they show that strong
institutions, high quality domestic policies, and outward-oriented policies partly mitigate the
adverse effect of debt on economic growth. In addition, the paper shows that a simultaneous
sharp reduction in public debt and an improvement in the policy environment induce an
increase in the growth rate per capita of 1.7 percentage points for the Caribbean and 2
percentage points for South America.
Modigliani (2021), refining contributions by Buchanan (2013) and Meade (2010), argued that
the national debt is a burden for the next generations, which comes in the form of a reduced
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flow of income from a lower stock of private capital. Apart from a direct crowding out effect,
he also pointed to the impact on long term interest rates, possibly in a nonlinear form if the
government operation is of sizable proportions it may significantly drive up long-term interest
rates since the reduction of private capital will tend to increase its marginal product. Even when
the national debt is generated as a counter cyclical measure and in spite of the easiest possible
monetary policy with the whole structure of interest rates reduced to its lowest feasible level,
the debt increase will generally not be costless for future generations despite being
advantageous to the current generation. Modigliani considered that a situation in which the
gross burden of national debt may be offset in part or in total is when debt finances government
expenditure that could contribute to the real income of future generations, such as productive
public capital formation.
Diamond (2015) adds the effect of taxes on the capital stock and differentiates between public
external and internal debt. He concludes that, through the impact of taxes needed to finance the
interest payments, both types of public debt reduce the available lifetime consumption of
taxpayers, as well as their saving, and thus the capital stock. In addition, he contends that
internal a debt can produce a further reduction in the capital stock arising from the substitution
of government debt for physical capital in individual portfolios.
Mitchell (2015) conducted a study aimed at investigating the impact of government spending
on economic performance in the United States of America. He concluded that a large and
growing government is not conducive to better economic performance. He also noted that
indeed, that there are circumstances in which lower levels of government spending would
enhance economic growth and other circumstances in which higher levels of government
spending would be desirable. It is assumed that if government spending is zero, presumably
there will be very little economic performance. He further noted that economists will generally
agree that government spending becomes a burden at some point, either because government
spending becomes too large or because outlays are misallocated.
However, studies such as Barro (2013), Easterly and Levin (2014) indicate that the relationship
between government spending and economic growth is negative. Elmendorf and Mankiw
(2019) also argued that public debt contracted to finance the budget deficit is a primary source
of crowding out private investment. The implication of huge borrowings by the government is
an increase in interest rates. The increase in interest rates may crowd out private sector
investment in plant and equipment. This decline in investment mean that the overall economy
has a smaller capital stock with which to work, which then decreases future growth rates. A
further argument advanced by Elmendorf and Mankiw is the effect of a budget deficit on
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savings accumulation. An increased flow of government borrowing can result in distortionary
tax measures which can incite dissaving behavior among consumers and consequently raise
interest rates. By implication, this reduces investible fun s and raises the cost of capital through
high interest rates. The result is a decline in private sector investment.
Adam and Bevan (2015) find interaction effects between deficits and debt stocks, with high
debt stocks exacerbating the adverse consequences of high deficit. In a simple theoretical
model integrating the government budget constraint and debt financing, they find that an
increase in productive government expenditure, financed out of a rise in the tax rate, will be
growth enhancing only if the level of public debt is sufficiently low. The adverse effect of
public debt stock on economic growth has largely been explained by debt overhang hypothesis.
A number of studies has found that the composition or the type of debt matters. Using an auto
regressive distributed lag (ARDL) approach, AKram (2020) examined the impact of public
debt on economic growth and investment in Pakistan for the period 2009- 2019. He finds that
the public external debt has a negative relationship with per capita GDP and investment in
Pakistan, confirming the existence of a debt overhang effect.
Musa et al (2013) examined the relationship between economic growth, external debt and
domestic debt in South Africa over the period 2000 to 2011. They found that external debt has
a negative impact on the economic performance of South Africa. In contrast, they also show
that domestic debt had a positive impact on economic growth through encouraging productivity
and hence output growth.
Omet elal (2015) studied the impact of external debt on the performance of the Jordan economy
during the period 1970 to 2000. Using an endogenous growth model, the authors found that the
positive effect of external debt on growth rapidly changes as external debt levels increase above
the optimal level of 53 per cent of GDP. The authors noted that high debt levels are associated
with low growth since a higher distortionary tax burden on capital is required to service debt,
leading to a lower rate of return on capital, hence lower investment and growth. Using a
dynamic panel data model on 93 developing countries, Ricci et al (2002) examined the impact
of external debt on developing countries during the period 1969 to 1998. The findings showed
that the average impact of debt on per capita growth becomes negative for debt levels above
160per cent to170 per cent of exports and 35 per cent to 40 per cent of GDP.
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With regards to Jamaica, Blavy (2016) in his study on productivity in Jamaica found that debt
service crowded out investment in Jamaica, and as a result adversely affects productivity
growth. He also showed that low levels of debt in Jamaica are associated with positive growth
in productivity
Amandeep (2015), studied the effects of public debt, economic growth and Gross investment
in India. The paper analyses the empirical relation-ship between public debt and economic
growth in India for a period of 32 years (1981-82 to 2012-13). The study confines only to the
central government debt and excludes the debt of state governments, union territory
governments, central public sector undertakings and public financial institutions. The
Stationarity Test has been conducted using augmented dickey-fuller test (ADF). And in order
to check the causal relationship between Gross domestic debt and Economic growth, Granger
Causality (2009) was performed. Furthermore, Multiple Regression has been worked out to
investigate the indirect relationship between economic growth and public debt. The study
provides evidence of positive, but indirect relationship between public debt and economic
growth via investment. The results show the positive and statistically significant relationship
between public debt and investment and also Public debt effects the economic growth
significantly.
Debi (2014) the paper examines the effect of Public Debt on Economic Growth in India
between 1980 and 2011. This study takes additional key macro-economic indicators, such as
internal and external debt, debt service payment, total factor productivity and export into the
growth equation, and examines the relationship between debt and economic growth in an
extended growth accounting frame work for India. Secondly this study uses more statistical
methodology to explore both short – run and long- run effects of public debt on economic
growth using the auto-regressive distributed lag (ARDL) model
Pesaran et al (2014) analytic framework used in the study involves the measurement of India’s
total factor productivity (TFP) growth using the Malmquist approach, and the ARDL model.
After performing the Augumented Dickey Fuller test (ADF) to know the order of the variables.
The results reveal that the model follows a mixture of I(0) and I(1) and it was found that there
exists a long- run relationship between public debt and economic growth. Both domestic debt
and external debt have a negative impact on economic growth of India. This implies that higher
the public debt, irrespective of its source is reducing economic growth in India in the long-run.
And the policy implications suggested by them states that it would be advisable for the
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government to follow the objective of inter-generational equity in fiscal management over the
long-term.
Younis (2013) analysed the negative impacts of external debt and economic growth of Iraq and
also to identify and explain why external debt exists as well as determine the nature and extent
of relationship between external debt and economic growth of Iraq. To fulfil the objective, the
paper adopted ARDL approach to estimate the level of co-integration and relationship between
external debt and economic growth as discussed in Pesaran and Shin (2019) and secondary data
from 1980-2014 has been used. After the test of Stationarity, present study employs the ARDL
bounds testing approach to co-integration analysis to investigate the presence of any cointegration between variables in economic growth model. And then long-run and short-run
estimation for the economic growth model is conducted using ARDL approach. The result
shows that by applying the value of external debt and exchange rate, it is found that all these
variables significantly affect the GDP of Iraq in the long run and that a one per cent increases
in external debt decreases the Iraqi GDP by 0.33%and a one per cent increase in exchange rate
increases the GDP of Iraq by 0.22% in the long run.
The short-run estimations of economic growth are different from its long-run estimations that
is, a one per cent increases in external debt decreases the GDP by 0.55 % and a 1%increase in
exchange rate increases the GDP by 0.36% in the short run. In sum, therefore, external debt
has a greater negative impact on economic growth in the short run compared to the long run.
This study indicates that increasing military expenditure, falling of GDP, falling oil revenue,
and irrationality in managing Iraqi economy; they were all major reasons to government
stimulated for external debt and accumulating external debts on Iraq. Thus, study concludes
that Iraq government should be given the opportunity to extensively develop the agriculture
and industrial sectors, which are important factors to meet the growing gross domestic product
(GDP) without depend mainly on oil sector which is directly and indirectly cause to external
debt.
2.2.2 Regional perspective
Isa (2014) also applied the OLS technique using time series data to examine the impact of
external debt on economic growth and public investment in Nigeria from 2003-2013. The
debt service burden was said to impede the Country’s rapid economic development and
worsened the social problems. Service delivery by key institutions designed to mitigate the
living condition of vulnerable groups were hampered by decaying infrastructure due to
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inadequate funding. By cutting down expenditure on social and economic infrastructure, the
Government appears to have also constrained private sector investment and growth. He
concluded that debt overhang was the major factor that contributed largely to the poor
performance of Nigeria’s economy during the period under review.
Christabell (2013), the objective of the study was to establish the relationship between public
debt and economic growth in Kenya. The study used secondary data collected from various
sources collected from the Kenya National Bureau of Statistics and the Central Bank of Kenya.
The study period included 2002/2003-2011/2012 financial periods. The data was collected
using data collection sheet which was edited, coded and cleaned. To establish the relationship
between public debt and economic development, the study conducted a regression analysis.
The determinants considered in the study that effect economic growth are investment levels in
an economy, human capital adequacy, economic policy and macroeconomic variables,
openness to trade, Foreign Direct investment, political factors and demographic factors. The
study adopted a descriptive research design. The study used Statistical Package for Social
Sciences Version 21.0 to aid in data analysis.
Hassan and Mamman (2013) examined the contribution of external debt to the economic
growth in Nigeria over the period 1970 to 2010, through the use of an ordinary least square
(OLS) model. The authors result showed an inverse relationship between external debt and
economic growth in Nigeria. However, Hassan and Mamman (2013) showed that debt service
payments have a positive impact on economic growth in Nigeria. The authors explained that
as the country pays its debts, it avoids the accumulation of interests and penalties thereby
attracting foreign aid, foreign direct investments and other international opportunities that
boost the economy in the long-run.
Kumar and Woo (2010) also explore the impact of high public debt on economic growth in the
long term. They base their analysis on a range of advanced and emerging economies during the
period from 1970 to 2007. The empirical results suggest an inverse relationship between initial
debt and subsequent growth. When the debt to GDP ratio increased ten percentage point, the
annual growth real GDP per capital decrease by about 0.2 percentage points per year, with a
more muted impact advanced economies. Only high levels of debt above 90% of GDP have a
significant negative effect on growth.
The paired t-test, a non-parametric test of differences developed by Sir Williams Gosset
(Mugenda, 2014) is used in this study as a test of significance. The analysis was at 0.05 level
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of significance. In order to determine the relationship between public debt and economic
growth in Kenya, the researcher conducted a multiple regression analysis. The study was based
on Harrod-Domar growth model. The study concludes that public debt greatly affects economic
growth in Kenya. The findings as shown in the regression analysis shows that public debt
affected economic growth in Kenya up to 96.20% and the study established that external loans
positively affect consumption, investment, imports and GNP. Analysis of the individual
components of both public and domestic debt with the exception of treasury bills and treasury
bonds, all other variables had negative relationship with economic development. The findings
in this study also showed that domestic debt has moderate effects on economic growth in
Kenya. These included treasury bills and treasury bonds. The study established that a unit
change in treasury bonds holding the other factors constant will lead to change the economic
growth by 1.381; a unit change in treasury bills holding the other factors constant will change
economic growth by 1.312. A unit change in overdraft at the central bank of Kenya holding
other factors constant will change economic growth by -2.46, a unit change in public debts
holding the other factors constant will change the economic growth by -0.465.
Krugman (2014) thus defines debt overhang as a situation in which investments are reduced or
postponed since the private sector anticipates that the returns from their investment will serve
to pay back creditors. Implying, that, the expected future public debt service of a country is
likely to be an increasing function of a country’s output level. Therefore, huge accumulation
of public debt stock creates uncertainty behavior among investors on the actions and policies
that the government will adopt to meet its debt servicing obligations. In this regard, Krugman
contends that most potential investors will assume that government will finance its debt service
obligations through distortionary tax measures, thus they will adopt a wait and see attitude
which will affect private investments and therefore economic growth.
Elmendorf and Mankiw (2019) argued that, an important channel through which public debt
accumulation can affect growth is that of long term interest rates. Higher long term interests
resulting from more debt financed government budget deficit, can crowd out private
investment, thus dampening potential output growth. Indeed, if higher public financing needs
push up sovereign debt yields, this may induce an increased net flow of funds out of the private
sector into the public sector. This may lead to an increase in private interest rates and a decrease
in private spending growth, both by households and firms.
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Cecchetti and Zampolli (2014) carried a study on the real effect of debt in 2011, the study used
a new dataset that included the level of government debt, non-financial, corporate and
household debt in 18 OECD countries from 1980 to 2010. They found out that advanced
countries with high debt levels must act quickly and decisively to address their looming fiscal
problems. The longer they wait, the bigger the negative impact will be on growth, and the
harder it will be to adjust.
Researchers in the likes of Panizza and Presbitero (2013), Cecchetti, Mohanty and Zampolli
(2011) and Egert (2012) have found out that there is a negative relationship between public
debt and economic growth. Shabir (2013) explored the long run relationship between external
debt and economic growth in developing economies, by using a sample 70 developing
countries over a period of 1976-2011.
The study found that an increase in eternal debt reducers fiscal space to service external debt t
liabilities and thus dampens the economic growth. Moreover, it reduces the level of private
fixed capital formation in the country. Exploring the role of investment towards economic
growth, the study found that both the foreign direct investment and the fixed capital formation
help these economies grow, while openness contributes to the welfare of the developing
economies.
Solomon Bueronortey Adi (2019) studied the impact of public debt on economic growth in
Ghana from 1965 to 2017 using descriptive statistics and multiple regressions in the main data
analysis. The study used controlling variables such as population growth, government
expenditure, inflation, trade openness and government intervention using ordinary least squares
(OLS) model with robust standard errors. He concluded that public debt had a positive impact
on economic growth in Ghana. Furthermore, the study recorded a negative correlation between
inflation and economic growth. Meaning periods when inflation was high, economic activities
were low and on the other hand, when inflation was low, economic activities were high. To
add on, the study also observed no correlation between government expenditure and economic
growth. Finally, his study found that investments towards education, agriculture and the health
sector by the government have enhanced growth and development in the years under review.
Safdari and Mehrizi (2011) investigated the effect of external debt on economic growth in Iran
for the period of 1974-2007 by observing the balance and long term relation between five
variables: gross domestic product (GDP), private investment, public investment, external debt
and imports. They employed the vector autoregressive model (VAR) in their econometric
analysis. The result of the research showed that external debt and imports had a negative effect
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on gross domestic product, but variables of private and public investment had positive effects
on economic growth.
According to Mukui (2013) on effect of external public debt on economic growth in Kenya
from 1980-2011. Variables that were used in his research include labour force, domestic
savings, physical capital formation, foreign direct investment and inflation. All these findings
were based on Kenyan data for the period of 1980-2011, which was all analysed using a linear
model. It was observed that external debt had a negative effect on economic growth in Kenya..
The researcher also noted that inflation rate and domestic savings had negative effects on
economic growth. By contrast, capital formation and foreign direct investment had a positive
effect on economic growth.
Cholifihani (2014) applied a production function model using a VEC to analyse the
relationship between public debt and economic growth in Indonesia for the time period of
2003 to 2013. The study concluded that in the short run, the change in capital stock boost up
economic growth but in the long run the debt service slowed down economic growth.
A vector error correction model was also employed by Isu et al (2014) to analyse the impact
of public external debt on economic growth in Nigeria. Using the national identity
framework, a negative long run relationship between external debt and growth was
observed. The results were both significant and consistent with theory. The VEC based
granger causality was also applied to detect the direction of causality. Uni-directional
causality was found to run from external debt to public debt service while a bi-directional
causality was found to be present between external debt and economic growth.
Abula and Mathew (2016) examined the impact of public debt on economic growth of Nigeria
using annual time series data spanning 1986 to 2014. In their study, they employed the
Augmented Dickey-Fuller test, Johansen co-integration test, Error Correction Method (ECM)
and the Granger Causality test. The Johansen co-integration test results revealed the presence
of a long-run relationship among the variables external debt, domestic debt, external debt
servicing, domestic debt servicing and economic development (proxied with GDP per capita)
in Nigeria. The ECM results revealed that external debt stock and external debt servicing have
insignificant negative relationship with economic development in Nigeria, however, domestic
debt stock has a direct and significant relationship with economic development while domestic
debt service payment was significant but inversely related to economic development in Nigeria.
The lagged error correction terms in ECM 1 and ECM 2 equations are high and statistically
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significant judging from its high and negatively signed coefficient. The study therefore
recommended that the government should reduce the level of external debt it accumulates
overtime, but domestic debt accumulation would contribute significantly to the development
of the economy.
Amos Tendai Munzara (2015) investigates the impact of foreign debt on economic growth in
Zimbabwe. Time series data covering the period 1980 -2013 is analysed using ordinary least
squares (OLS) regression. Labour force, capital investment, and trade openness are used as
control variables. The country’s debt burden is unsustainable as evidenced by the high external
debt to export ratio which is around 200%. The debt overhung has impacted negatively on the
country’s credit rating making it difficult for the country to further borrow on international
capital markets. The study concludes that external debt and trade openness impacts negatively
on economic growth in Zimbabwe while capital investment and labour force growth has
positive effects. The huge external debt burden has the effect of stifling the much needed
economic growth and has become a barrier preventing the country from accessing further lines
of credit. The study also recommends that the country should rely on other forms of
development finance like foreign direct investment (FDI) and project finance instead of heavily
relying on foreign borrowing.
2.2.3 Local perspective
In the case of Zambia the study undertaken by Chikuba (2013) focused only on public
external debt effects on growth from 2000 to 2010. The study concluded that there was
crowding out of investment in Zambia due to the presence of debt overhang. The study
applied the two-stage-least squares regression approach and OLS to estimate the growth and
investment model respectively. The two-stage-least squares technique was applied to cater
for endogeneity problem between the debt and growth variables. Like other studies so far
analysed in this section, his results were valid and consistent with theoretical arguments,
however the methodology did not state the direction of causation effect.
Further, the study undertaken by Chikuba (2013) did not take into account the effects of
public domestic debt on growth, despite being on the increase. This study has filled in this
information gap by analysing the short and long run economic growth effects of a rising
public debt stock (both domestic and external public debt) in Zambia covering both the pre
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and post HIPC periods from 1980 to 2008. A further contribution by this study is the
analysis of the short and long run impact of public debt on the empirical determinants of
economic growth which is important for policy guidance.
2.3 Theoretical framework
2.3.1 The debt overhang theory
External borrowing is covered with the perceived negative relationship between foreign debt
and investment which consequently results into lower capital formation. Krugman (2014)
defines this negative relationship as “debt overhang” where the potentials of repayment of
outstanding facilities fall lower than the signed value. Several scholars have supported the
theoretical case for debt overhang. Some of the studies include Krugman (1988) and Sachs
(1988). Others like Greene and Villanueva (1991), Elbadawi et al. (1997) and Chowdhury
(2001) reaffirmed this by coming up with ample proof that backs the debt overhang
phenomenon.
In those economies with heavy indebtedness “debt overhang” is considered a leading cause of
distortion and slowing down of economic development (Sachs, 1989; Bulow and Rogoff,
1990). Economic development slows down because these countries lose their pull on private
investors. Additionally, servicing of debts exhausts up so much of the indebted country’s
revenue to the extent that the potential of returning to growth paths is abridged (LevyLivermore and Chowdhury, 1998). They suggested that even if structural adjustment programs
are put in place by governments of these countries, adverse effects can still be felt on
development of general economic performance. It should however be noted that debt overhang
does not occur only when a country accumulates too much debt, it can also arise when country’s
circumstances change, making it difficult to manage and discharge its stocks of debts. Such
conditions may emerge because of adverse economic shocks or poor economic policies
(Arslanalp and Henry, 2004) and in these unfavorable circumstances, creditors loan portfolios
will face heavier risks. The outcome would be panic among creditors who rush to cash their
claims, and the withdrawal of interest from potential new credits.
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2.3.2 The dual gap theory
The dual gap model propounded by Chenery and Strout (1966) underscores that indebtedness
is associated with an imbalance, and depending on the case, it is the imbalance between savings
and investment, and the budget deficit and the current account deficit. Thus, external borrowing
becomes a necessity. The most important consideration in contracting external debt is a simple
and direct one; signing up for debt from abroad only when the funds can generate higher returns
than the cost of funds when invested. It therefore follows that borrowing nations would be
enhancing their productivity and national output through the investment facilitated by
borrowed funds. The dual-gap concept refers to the function of foreign capital in the economic
development process. The role of foreign capital here is that it permits developing countries to
invest more than they can save domestically; which is a necessity resulting from deficits in
internal savings (McKinnon, 1964). Consequently, the model recommends that external
savings should condition economic development if the savings-investment and import-export
imbalances are to be corrected. These authors believe that domestically, it entails accumulating
the savings needed to finance domestic investment and externally, finding the resources needed
to finance the balance of payments deficit.
2.4 Conceptual framework
Manlimpo (2014) asserted that the conceptual framework puts the stage for the demonstration
of study enquiries founded on the theme under study. The Conceptual Framework (Concepts
Statements) is a frame of interconnected goals and nitty-gritties. Nombo (2010) proclaims that
a conceptual framework embodies the investigator’s amalgamation of collected works on how
to elucidate a phenomenon. It maps out the activities essential in the progression of the research
given the preceding information of other scholars’ viewpoint and investigator’s opinions on
the topic. The conceptual framework connects the independent variables to dependent variable.
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DEPENDENT VARIABLE
Real Gross
Domestic Product
INDEPENDENT VARIABLE
Exchange Rate
External Public Debt
Domestic Public Debt
Figure 2.1: Conceptual framework
The deducted concept is shown in the figure 2.1. The diagram shows Real Gross Domestic
Product (RGDP) as a variable which is dependent on Exchange rates, Eternal public debt and
domestic public dent.
2.5 Gaps in literature
Various attempts have been made to study the effect of public debt on economic growth. The
studies however remain with a mixed outcome. Empirical studies above focused much about
how external debt affects economic growth with little or no emphasis about domestic debt. Not
too many studies focusing on either public external or domestic debt have been undertaken in
Zambia thus creating a gap in information especially for policy guidance. The other gap spotted
was that researchers did not account on how exchange rates affects economic growth. It is for
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this reason that there is a complete need to critically assess all the factors that affect public debt
and be able to fill in the gaps that were left by previous researchers.
2.6 Chapter Summary
This chapter has deliberated on the literature relating to the impact of public debt on economic
growth the theoretical and conceptual framework. The chapter has also offered a critique of the
literature. The next chapter looks at the research method to be employed in the study, the data
collection techniques to be used and the model specification.
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CHAPTER THREE:
METHODOLOGY
3.1 Introduction
According to Perry (2014), the main goal of the chapter on methodology is to give a detailed
amount of all the major methodology used in research. Punch (2010) attests that a welldocumented research is a good marriage between its research questions and the methods that
are used. This chapter covers the research approach, research design, model specification, data
sources, data estimation techniques and procedures and finally research validity and reliability.
3.2 Research approach
Based on the research hypothesis and the problem at hand, this research will adopt a
quantitative research study approach.
3.3 Research design
This study will use time series data from 2011 to 2021. This period has been chosen because it
is a period were Zambia acquired so much debt both globally and internally. Time series data
made it possible to analyze the change and developments over the stated period of time.
3.4 Model specification
The Autoregressive distributed lags model (ARDL) model will be used in the study. The model
will be formulated using GDP as the dependent variable while the explanatory variables were
Domestic Debts stock, External Debts stock and Exchange rate. Prime Lending Rate was used
as a control variable. The equation can be defined econometrically as below:
RGDP = αo + α1EXD + α2DMD + α3EXR + α4LR+ ui.
Where; αo = a constant
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α1, α2, α3, α4 = coefficient of the independent variables
RGDP = Real Gross Domestic Product
LR = Prime Lending Rate
EXR= Exchange rate
EXD = External Debt Stock
DMD = Domestic Debt Stock
ui = error term
3.5 Priori expectation
Explanatory variable
Expected sign
External Public debt
-
Domestic Public debt
-
Lending rates
+
Exchange rate
+
3.6 Sample size
The study will consist of 120 monthly observations from January 2011 to December 2021.
This sample size will be sufficiently enough to make generalizations from the findings.
Besides, this is the most recent data.
3.7 Data sources
Secondary data will be used for the study. Secondary data refers to data that is collected by
someone other than the primary user. Common sources of secondary data for social science
include censuses, information collected by government departments, organizational records
and data that was originally collected for other research purposes (Marvin, 2019). Secondary
data for this study will be collected from the Bank of Zambia.
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3.8 Data estimation techniques and techniques procedures
Time series data from 2011-2021 will be estimated using Co-integration technique of analysis
which is an improvement on the classical ordinary least square technique (OLS). The following
techniques of estimation will be employed in carrying out the co-integration analysis:

Unit Root Test: This is the pre Co-integration test. It is used to determine the order of
integration of a variable that is how many times it has to be differenced or not to
become stationary. It is to check for the presence of a unit root in the variable i.e.
whether the variable is stationary or not. The null hypothesis is that there is no unit
root. This test is carried out using the Augmented Dickey Fuller (ADF) technique of
estimation. The rule is that if the ADF test statistic is greater than the 5 percent critical
value we accept the null hypothesis i.e. the variable is stationary but if the ADF test
statistic is less than the 5 percent critical value i.e. the variable is non-stationary we
reject the null hypothesis and go ahead to difference once. If the variable does not
become stationary at first difference, we difference twice. However, it is expected that
the variable becomes stationary at first difference.

Co-integration: After the test for the order of integration, the next step is to test for cointegration. This test is used to check if long run relationship exists among the variables
in the model. This will be carried out using the Johansen technique.

Causality Test: This is used to check for causality between two variables. In this case
our aim was to test for a causal relationship between public debt and economic
development. The rule states that if the probability value is between 0 and 0.05 there is
a causal relationship.
3.9 Diagnostic tests
3.9.1 Autocorrelation Test
The presence of autocorrelation is a sign of dependent observations, risking the study yielding
spurious results. To test for autocorrelation, the study used the Lagrange Multiplier test, whose
null hypothesis assumes no autocorrelation, or at lag order. Serial correlation auto-correlation,
occurs when the model’s error terms transfer from one period to another (Gujarati, Porter, &
Gunasekar, 2009). The presence of serial correlation indicates that the model is unsound, as it
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will most likely be incorrectly specified or its explanatory variables are not independent of each
other.
Autocorrelation in the model shows that the estimators though linear, unbiased, and
asymptotically normally distributed are not efficient relative to other linear and unbiased
estimators thus the conclusion drawn from such tend to be invalid. When the p- value is greater
than 0.05, the null hypothesis which states that there is no autocorrelation is rejected.
3.9.2 Heteroscedasticity Test
Without testing for heteroscedasticity in the model, it would mean that all the conclusions that
can be drawn may be misleading. Therefore, the researcher tested the data for
heteroscedasticity using the Breusch-Pagan-Godfrey. If the p-value is found to be less than 5%
then we fail to reject the null hypothesis that there is homoscedasticity. We therefore conclude
that there is no heteroscedasticity in the ARDL model that is estimated.
3.9.3 Normality Test
Econometricians often assume that the residuals of a model follow a normal distribution
(Gujurati, 2004). Models that do not fit this assumption cannot be assumed to be randomly
sampled, implying that the model does not adequately explain the trends in the dataset
(Veroustraete, 2014). The researcher adopted the Jarque-Bera test for normality was adopted;
whose null hypothesis assumes normally distributed residuals. The decision rule is that if the
p-value exceeds 0.05 (5%), the null hypothesis is not rejected.
3.9.4 Model Stability Test
A stable model is one that will not diverge to infinity in the long-run, implying Stationarity.
Thus the researcher tested the data for stability on the ARDL model conducted on the variables
selected. The researcher adopted the Eigen value Stability Condition. When all the moduli lie
within the eigen value criteria, then the ARDL model satisfies the stability criteria (Gujarati
and Gunasekar, 2009).
3.10 Research validity and reliability
This research study will use secondary data that is readily available and will be assembled from
the Bank of Zambia, a competent institution, something that will enhance the reliability and
validity of this study.
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3.11 Ethical Considerations
Data collection has to follow stipulated ethical measures, protect and maintain the interest both
the researcher and the researched at all times (Bell, 1995). Ethical considerations are important
because they ensure that there is fairness in the manner in which the research is conducted.
Therefore, informed Consent will be provided and permission will be sought from the
University of Zambia to proceed with the study.
3.12 Chapter summary
This chapter looked at how data of the research will be gathered, the research method to be
employed in the study, the data collection techniques to be used and the model specifications,
the sample size and sampling techniques as well as the data analysis methods that were
employed. The next chapter focuses on data analyses based on the findings of the study.
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