Unpacking The Contributing And Mitigating Factors of External Debt In Pakistan: An Ardl And Local Projection Approach

Abstract

This study aims to investigate the root causes of burgeoning external debt in Pakistan and to identify potential ways to minimise the growing burden of external debt. By analyzing time series data from 1976 to 2022, using the Auto Regressive Distributive Lag Model (ARDL) bound test and local projection impulse response, the research finds a long-term relationship among remittances, external debt, and other variables. The results indicate that gross domestic product (GDP) growth rate, trade volume, and foreign exchange reserves play crucial roles in mitigating Pakistan’s external debt, offering avenues for reducing the country’s debt burden, as the probability values of their coefficients are less than 0.05. However, remittances, gross capital formation, and external debt servicing contribute to increasing external debt at a 5% significance level. The negative and significant error correction term (ECT) implies the system’s stability and convergence. The study concludes that while remittances and gross capital formation have contributed to the increasing external debt, effective management of GDP growth, trade volume, and foreign exchange reserves can mitigate this burden. Based on these findings, it is recommended that the Government of Pakistan prioritize enhancing the GDP growth rate by channelling remittances and other foreign currency inflows, such as Foreign Direct Investment (FDI), foreign grants, and export earnings, towards building up foreign reserves.