Fiscal Sustainability and Debt Dynamics: Evidence from South Asian Countries

Abstract

This paper undertakes a comprehensive analysis of the interplay between defense expenditure, democracy, and external debt in five South Asian countries spanning the period from 1972 to 2017. Employing a range of econometric techniques including pooled mean group, mean group, dynamic ordinary least squares, and fully modified ordinary least squares, the study ensures robustness and precision in its empirical analysis. The findings of the study reveal compelling insights into the determinants of external debt in the context of South Asian nations. Firstly, the results confirm the presence of a long-run relationship between military expenditures and external debt, highlighting the significant role played by defense spending in shaping the debt dynamics of these countries. This underscores the importance of prudent fiscal management and strategic allocation of resources in mitigating the burden of external debt. Furthermore, the study elucidates a negative relationship between democracy and external debt, suggesting that countries with stronger democratic institutions tend to exhibit lower levels of external indebtedness. This intriguing finding underscores the potential benefits of democratic governance in promoting fiscal discipline and accountability, thereby reducing reliance on external borrowing. Based on these empirical results, the paper offers valuable policy recommendations aimed at enhancing fiscal sustainability and debt management practices in South Asian countries. Such recommendations may include measures to rationalize defense expenditures, strengthen democratic institutions, improve transparency and accountability in public finances, and diversify sources of financing to reduce reliance on external borrowing. Overall, this paper contributes to our understanding of the complex factors driving external debt dynamics in South Asia, offering insights that are pertinent for policymakers, researchers, and practitioners engaged in economic governance and development efforts in the region.