Towards A Debt-Overhanged Economy: Causes and Consequences for the Economy of Pakistan

Abstract

The reliance on debt is not only essential but also a key factor in economic growth of poor countries like Pakistan because of a meager tax base and an annuity of fiscal deficit. Trade surplus is a common tool that covers the budget deficit but twin deficit makes the economic conditions worst. The excessive borrowing can stimulate the economic cycle in the short run but in the in the long-run it creates the issues of debt-overhang. This timely study is an attempt to investigate the short-run and long-run dynamics of debt on the economy of Pakistan. The empirical results (ARDL co-integration) suggests that long-run relationships exist among the variables under consideration such as Exports and Remittances have negative effects on debt,  while other variables have positive effects. The Error-Correction-Model (ECM) analysis indicates mean-reverting behavior, where the dependent variable returns to its long-run equilibrium. Post-estimation tests support the model's assumptions. The Jarque–Bera test shows that residuals exhibit normal distribution. CUSUM and CUSUMsq tests indicate reliability and stability of the regression model. There is a long-run relationship between exports of goods and services (EGS), imports of goods and services (IGS), gross fixed capital formation (GFCF), net official development assistance (NOD), personal remittances (PRR), and debt in Pakistan. In the long-run, Exports of goods and services have a negative impact, Imports of goods and services have a significantly positive impact, Gross fixed capital formation has a positive impact, Net official development assistance has a positive impact, Personal remittances have a negative impact on debt respectively. However, Trade as a percentage of GDP has an insignificant impact on debt in the long run. The study also found that the impact of each variable on Debt is different in the short run. Overall, the study provides valuable insights into the factors that affect Debt in Pakistan.