External debt in developing countries: Unravelling the threshold for sustainable development

Abstract

Amidst escalating levels of developing nation’s external debt, the quest to unravel a threshold conducive to sustainable development intensifies. While previous studies have identified external debt thresholds for economic growth, human development and environmental sustainability, these dimensional thresholds are isolated and unable to account for their inherent counteractions. The optimal level of external debt that supports sustainable development in developing countries therefore remains unclear. To address this gap, the study adopted the adjusted net savings to GDP ratio as a measure of sustainable development in fifty-two (52) lower-income and middle-income countries for the period 2008-2021. This measure incorporates all dimensions of sustainable development, thereby internalising their counteractions. Although the main estimation model was a dynamic panel threshold model (with kink specification) (Seo and Shin, 2016), the fixed effects, random effects, pooled OLS and the two-step difference GMM were estimated to check the reliability of the result. A threshold of 30.33% of GDP was identified. Below this threshold, the lag of external debt to GDP ratio promotes sustainable development, but the effect changes to negative when the threshold is exceeded. Notably, the identified threshold is lower than the dimensional thresholds found in previous studies, and it challenges the conventionally accepted debt-to-GDP ratio thresholds, which are only based on economic growth considerations, and argues for moderation in borrowing. Besides, the ongoing structural change in developing countries is seen to hamper sustainable development, emphasizing the need for a manufacturing sector revamp.