Unraveling the Interplay Between External Debt and Economic Growth: Insights from Pakistan's Macroeconomic Landscape

Abstract

The study's exploration into the nexus between external debt and economic growth in Pakistan provides a nuanced understanding of the country's macroeconomic dynamics. By employing an extended Solow growth model, the research goes beyond conventional analyses to uncover the multifaceted relationship between external borrowing and economic performance. In dissecting the impact of external debt on economic growth, the study delves into various channels through which high levels of indebtedness can exert downward pressure on growth prospects. These may include debt servicing obligations, which divert scarce resources away from productive investment, as well as the crowding-out effect, whereby private sector investment is crowded out by government borrowing in the credit market. Moreover, the study's comparative analysis with the Nigerian economy offers valuable insights into the generalizability of findings across different contexts, shedding light on common patterns and distinct factors shaping the debt-growth relationship in diverse economic settings. This comparative lens enhances the robustness and applicability of the study's findings, contributing to a more comprehensive understanding of the underlying mechanisms at play. Furthermore, the Granger causality tests conducted in the study not only elucidate the directional causality between key variables but also unveil the intricate interplay of economic forces shaping Pakistan's growth trajectory. By disentangling the causal relationships between GDP, external debt, and domestic debt, the research unveils critical insights into the transmission channels through which debt dynamics influence economic outcomes. In proposing strategic recommendations, the study emphasizes the imperative of proactive debt management strategies tailored to Pakistan's unique economic context. It underscores the importance of striking a delicate balance between leveraging external financing for development purposes while safeguarding fiscal sustainability and debt servicing capacity. Additionally, the study underscores the role of domestic debt as a potential catalyst for economic growth when utilized judiciously. By channeling domestic borrowing into productive investments, infrastructure development, and human capital enhancement, policymakers can harness the latent potential of domestic debt to stimulate economic activity and foster inclusive growth. In short, the study's comprehensive analysis offers a nuanced understanding of the complex interplay between external debt, economic growth, and domestic debt dynamics in Pakistan. By elucidating the mechanisms driving these relationships and offering actionable insights for policy formulation, the research serves as a valuable resource for policymakers, researchers, and stakeholders seeking to navigate the intricate terrain of debt sustainability and economic development.