WOLKITE UNIVERSITY

COLLEGE OF BUSSINESS AND ECONOMICS

DEPARTMENT OF ECONOMICS

IMPACT OF EXTERNAL DEBT ON ETHIOPIA ECONOMIC GROWTH

A RESEARCH PAPER SUBMITTED IN PARTIAL FULFILLMENT OF THE

REQUIREMENTS FOR THE AWARD OF BACHELOR OF SCEINCE DEGREE (Bsc) IN
ECONOMICS

By: DAWIT GETACHEW

ID No: SSR/1222/13

ADVISOR: Dr. ABDULAZIZ A

April, 2024

WOLKITE, ETHIOPIA
2
Board of examiners Approval sheet
This is to certify that this senior research paper prepared by DAWIT GETACHEW entitled
"IMPACT OF EXTERNAL DEBT ON ETHIOPIAN ECONOMIC GROWTH” submitted in
partial fulfillment of the requirement for the degree of Bachelor of art in Economics complies with
the regulations of the university meets the accepted standards with respect of originality and equity.

Signed by Board of examiners:

Examiner: ______________________; Signature: _________________; Date: _______________

Examiner: ______________________; Signature: _________________; Date: _______________

Advisor: _______________________; Signature: _________________; Date: _______________

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i
ACKNOWLEDGEMENTS
First and foremost, I want to express my profound gratitude to Almighty God who enabled me
with his divine mercy to go through this academic journey and arrived successfully at the end with
sound health.

Second, my sincere gratitude goes to my supervisor, Dr. ABDULAZIZ A for his constructive
criticisms, suggestions and corrections that helped shaped the work. Third, I am also much grateful
and warmest appreciation goes to my Dad GETACHEW WOLDE, my mum FANTU BERTAWE,
my siblings and my uncle MELAKU BERTAWE for their help and financial and moral support in
all academics achievements. My appreciation also goes to my cousin BEREKET MELAKU for
the academic knowledge, suggestions and advice given to me before, during, and after the various
departmental and faculty research work. Finally, to my special friends; MEKBIB MESFIN and
ANDAMLAK GEBREMARIAM in all ways.

ii
 |Page

Abstract
This paper examines the long run and short run relationship between external debt and economic
growth in Ethiopia using time series data for the period 2001 to 2021. To this end, the descriptive
and regression analysis were used. Using the long run co-integration test of ordinary least square
(OLS) method and short run error correction model (ECM), the findings of the study revealed that
external debt was negatively and significantly related to the economic growth both in short run
and long run. This indicated the existence of debt overhang problem in the country. But, the other
debt burden indicating variable, external debt service export ratio positively but significantly
related to economic growth which shows the absence of crowding out effect. The study also tested
for time series behaviours like presence of stationarity, co-integration, autocorrelation and model
specification problems to guard against spurious results. The researcher recommends that
External debt ought to be utilized properly and wisely by being invested on prioritized and most
productive investment, only be contracted when it is really needed to finance projects or
investments that will significantly contribute for the growth and development of the economy, and
channel the borrowed fund to the productive real sectors of the economy rather than social
consumption.

Keywords: Key Words:

External Debt, Debt overhang, Debt crowding out, debt servicing

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Contents
Board of examiners Approval sheet............................................................................................................... i
ACKNOWLEDGEMENTS ................................................................................................................................. ii
Abstract........................................................................................................................................................ iii

List of tables ............................................................................................................................................. iv

List of Figures ............................................................................................................................................. iv
List of Appendixes ..................................................................................................................................... iv
ACRONYMS ................................................................................................................................................. v
CHAPTER ONE ............................................................................................................................................ 1
1. INTRODUCTION .................................................................................................................................. 1
1.1. Background of the Study ................................................................................................... 1
1.2. Statement of the problem ................................................................................................ 2
1.3. Objectives of the study ..................................................................................................... 3
1.3.1. General objectives ........................................................................................................... 3
1.3.2. Specific objective of the study ........................................................................................ 3
1.4. Significance of the study .................................................................................................. 4
1.5. Hypothesis of the Study .................................................................................................... 4
1.6. Scope of the study ............................................................................................................ 4
1.7. Delimitation of the study ................................................................................................. 4
1.8. Organization of the Study ............................................................................................... 5
Chapter two .......................................................................................................................................... 6
2. Review of literature ............................................................................................................................ 6
2.1. Theoretical literature ...................................................................................................... 6
2.1.1. Contextual definition of External Debt ........................................................................... 6
2.1.2. Classifications of external debt ........................................................................................ 7
2.1.3. Causes of external debt ................................................................................................... 8
2.1.4. External debt and future generation ........................................................................... 11
2.2. Empirical Literature ....................................................................................................... 14
2.2.1. Related Studies in the Rest of the World ....................................................................... 14
2.2.2. Related studies in Ethiopia ............................................................................................ 15
 2.3. Conceptual framework ................................................................................................. 16
CHAPTER THREE ................................................................................................................................... 18

3. METHODOLOGY OF THE STUDY ........................................................................................................ 18

3.1. The data set..................................................................................................................... 18
3.1.1. Data Type and Source ..................................................................................................... 18
3.1.2. Data Analysis ................................................................................................................... 18
3.2. Model specification ....................................................................................................... 18
3.3. Definition of variables .................................................................................................... 22
3.3.1. Dependent Variable ...................................................................................................... 22
3.3.2. Independent variable ................................................................................................... 22
3.4. Economic estimation procedures ................................................................................. 23
3.4.1. Unit Root Test .............................................................................................................. 23
3.4.2. Co-integration Test ....................................................................................................... 24
3.4.3. Error Correction Model ................................................................................................ 25
Chapter 4 ......................................................................................................................................... 26
4. Data Presentation and Analysis ..................................................................................................... 26
4.1. Descriptive Statistics .................................................................................................... 26
4.2. Empirical Analysis ........................................................................................................ 27
4.2.1. ADF Unit Root Testing Result ....................................................................................... 27
4.2.2. Co-integration .............................................................................................................. 28
4.2.3. Diagnostic Tests ............................................................................................................ 29
4.3. Model Stability Testing Result ....................................................................................... 31
4.4. Error Correction Estimation Result ............................................................................... 33
Chapter 5 ................................................................................................................................................ 37
5. CONCLUSION AND POLICY RECOMMENDATION ............................................................................ 37
5.1. CONCLUSION ................................................................................................................... 37
5.2. POLICY RECOMMENDATION .......................................................................................... 38
Reference ................................................................................................................................................ 39
Appendix ................................................................................................................................................. 41
List of tables
Table 4.1 summary of descriptive analysis………………………………………………………26

Table 4.2 Results of unit root test……………………………………………………..…………27

Table 4.3 bound testing for co-integration………………………………………………………29

Table 4.4 Tests for multicollinearity problem...............................................................................29

Table 4.5 Tests for Auto-correlation problem…………………………………………….……...30

Table 4.6 Tests for heteroskedasticity problem………………………………………………….30

Table 4.7 Tests for Model specification problem…………………………………….………….30

Table 4.8 Tests for Normality test problem…………………………………………….………..31

TABLE 4.9 error correction estimation result…………………………………………………..34

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List of Figures
FIGURE 1: conceptual framework………………………………………………………………17

FIGURE 2: plot of cumulative sum of recursive residuals………………...…………………….32

FIGURE 3 plot of cumulative sum of squares recursive residuals………………………..……..32

List of Appendixes
Annex 1: Correlation matrix……………………………………………………………………..41

Annex 2: Descriptive Statistics………………………………..…………………………………41

Annex 3: Unit root test……………………………….......………………………………………41

Annex 4: Result of Bound Test for Co-Integration………………………………………………44

Annex 5: Diagnostic Tests…………………….…………………………………………………45

iv

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ACRONYMS
NBE National Bank of Ethiopia

MOFED Ministry of Finance and Economic Development

WB World Bank

IMF International Monetary Fund

GDP Gross Domestic Product

OPEC Overseas Petroleum Exporting Countries

VECM Vector error correction model

ARDLM Autoregressive Distributed Lag Model

CSA Central statistical agency

LDC Least developed countries

ADF Augmented Dickey Fuller

EG Engle-Granger

AEG Augmented Engle-Granger test

CRDW Co-integration regression on Durbin Watson

USD United State Dollar

EAL Ethiopian Airline

OLS Ordinary List square

v
 CHAPTER ONE
1. INTRODUCTION
1.1. Background of the Study
One of the greatest problems facing many LDCs in general and Sub-Saharan Africa in particular
is highly indebtedness beyond their repayment capacities. Historically, the 1950s and 1960s are
characterized as golden year for LDCs not only owing to high economic growth, but due to
homegrown achievements. On other hand, the growth of the 1970‘s was known as debt-led due to
the fact that these countries ran a persistent current account deficit and borrowed heavily to finance
the payments gap. In 1980s things went worse, and described as lost decade by some scholars as
external debt became the nightmare of policy makers rather than their blessing (singer, 1989). The
reasons lay not only in high interest and principal needed to be paid, but such servicing was made
from ever-decreasing foreign exchange earnings from the export of goods and services. More
importantly, this decade(1980s) marked the end of non-detrimental nature of external debts,
particularly when Mexico suspended repayments of its principal in the 1982, and ever since the
issue of external debt and its service has called for critical importance and introduced as debt-crisis
into the modern economic lexicon (Befekadu, 1992). Conformed to this general picture, the growth
in sub-Saharan Africa severely declined as it also combined with souring population growth,
constantly deteriorating terms of trade, inappropriate domestic policies and natural climates such
as drought.

Ethiopia is categorized as one of the heavily indebted poor countries (HIPCs) which have been
suffering with high debt burden (WB, 2000). The debt service burden that is the amount of foreign
exchange required to repay external debt has grown enormously for the entire developing countries
is self-evident. In the case of Ethiopia, the World Bank estimates that total debt service before debt
relief has been US$464.3 million for the year 1998. This is an amount beyond the capacity of the
country to meet (Befekadu & Berhanu, 1999/2000). Between 1999/00 to 2000/01, the debt stock
increased marginally from 5,394.00 million USD to 5,479.00 million USD. And also, during the
period from 2000/01 to 2003/04, debt stock rose from 5, 479.00 million USD to 7, 367.00 million
USD registering a 34 percent increase. After 2003/04, the total debt stock of the nation decreased
from 7,367.00 million USD in 2003/04 to 4.15 billion USD in 2008/09. This huge decline in debt
stock was associated with debt relief obtained as per the Enhanced – Highly Indebted Poor

1
Countries (HIPIC) initiative (Abinet, 2005) (Hailemariam, 2011). But after 2008/09 the debt stock
and debt service shows an increasing trend due to the government needing a high level of external
finance as a result of exaggerated public expenditure and budget deficit to achieve Millennium
Development Goals (MDGs). That is, total debt stock increased from 4.15 billion USD in 2008/09
to 8.87 billion USD in 2011/12.

1.2. Statement of the problem

The presence of external debt may constrain growth via two channels. First highly indebted
economy will discourage private investers from investing by expecting a higher rate of taxing their
output to repay the loan and hence results a lower level of economic growth. Second the
repayments of debt service results in pressure on the government budget and may reduce public
investment and social spending which in turn reduce economic growth (Idermit and Brain, 2005).
To many observers, debt is a new form of colonialism, different kinds of North-South relation, in
which western creditors, International Financial Institution (IFIs) and other leaders held the poor
countries in perpetual state of domination control. Communities, have holds and people’s live are
systematically destroyed using debt as a major weapon. However, to others capital movement i.e.,
external debt is assumed to be a source of economic growth by stimulating investment to those
who cannot buy their own internal capital (Abinet, 2005). Inability to service debt on time not only
makes it harder for the developing countries to get aid at concessional rates with less conditionals
from the donor agencies but it also increase the countries risk (Mulugeta, 2014).

Few studies pin down the vital role of the emerging field of external debt and debt indicators in
the Ethiopian economy with emphasis on the empirical relationship of external debt and economic
growth. Mulugeta F. (2014) used data from (1983-2012) evaluated the impact of external debt on
economic growth and came up with the result that reveals past external debt negatively affects
economic growth while current external debt inflows affect it positively.

Desta (2005) used co integration and EMC approach and reported that external debt stock impact
economic growth positively. Amsalu (2017) used data from (1982-2016) and deployed vector error
correction model then found external debt stock if it is utilized optimally, would have positive
impact on economic growth but external debt servicing had crowding out effect.

Some researcher such as Hana (2013) used co integration approach and deployed only data up 10
years to 2010, and conducted external debt servicing impacted economic positively even if the

2|Page The impact of external debt on Ethiopian economic growth (2001-2021)

result deviated from theory of crowding out effect. Tsigereda (2017) used VECM model and using
data from (1985-2015) and concluded external debt has negative impact on economic growth of
Ethiopia.

Further, most studies lack a more comprehensive analysis that includes important variables like
labor force, and gross investment as key determinants of economic growth. Thus, by taking into
account the above gap knowledge, this paper will address the impact of debt burden on economic
growth of Ethiopia using a time series data from (2001 to 2021) using appropriate methodology.

1.3. Objectives of the study

1.3.1. General objectives
The general objective of the study is to investigate the impact of external debt on Ethiopia’s
economic growth from the period 2001 to 2021.

1.3.2. Specific objective of the study

The specific objectives of the study include the following points.

✓ To find out the effect of debt servicing and stock of external debt on economic growth in
Ethiopia.
✓ To investigate the long-run and short run relationship between external debt (debt servicing
and stock of debt) and economic growth in Ethiopia.
✓ To examine the macroeconomic factors that determines external debt of Ethiopia.
✓ To draw policy conclusions based on the findings of the study for macroeconomic
management of external debt situation

1.4. Significance of the study

Most studies in this area consider only a small number of explanatory variables in trying to
establish a statistically significant relationship between debt and growth. However, economic
theory doesn’t provide a complete specification of which variable are to be held constant when
statistical test are performed on the relation between debt and growth (Cooley and LeRoy, 2001).

One of the significance of this study is that it employs an econometric model with strong theoretical
foundations that relate external debt and economic growth. Second, provide the dearth of empirical
studies on the relationship between debt and economic growth in Ethiopia, and the growing
concern of the subject of debt, it would be useful to explore the aforementioned issues and come
up with result would help in the policy building up of the Ethiopian economy. Thus, the outcomes
3|Page The impact of external debt on Ethiopian economic growth (2001-2021)
of this study may be used to fill gap through analyzing the impact of external debt burden on
economic growth. The empirical findings of this study are also expected to have insightful
implication for policy.

1.5. Hypothesis of the Study

➢ External debt servicing has indeterminate.
➢ Total external debt stock has negative impact on economic growth of Ethiopia.
➢ Capital formation has positive impact on economic growth in Ethiopia.
➢ Inflation has negative impact on economic growth of Ethiopia.
➢ Active Labour force has indeterminate.
➢ Movements in real exchange rate has positive impact of economic growth of
Ethiopia.

1.6. Scope of the study

The study of this paper is covering the time period from 2001-2021. The selection of this period is
by expecting there is organized data from sources. The study as well considers only the impact of
external debt on Ethiopian economic growth.

1.7. Delimitation of the study

The results of this study can be limited by the quality of the data series available. The limitation
may be raised from the problem of inconsistency of data as represented by different institutions.
Moreover, data from the same institutions may reveal different figures for the same year. To deal
with problems, the data from single source will be used for one variable.

1.8. Organization of the Study

This study will have five chapters. The first chapter is introduction part which contains the
background, problem statement, research question, objective, hypothesis, scope, and significance
will discuss. The second chapter examines relevant literature theoretically and empirically and also
have conceptual frameworks. Chapter three focuses on methodological issues that were reveal the
method of data type and source, method of data analysis, test and distributive analysis and the
econometric model. Chapter four encompass the presentation and analysis of empirical results
obtained from the regressions result. Finally, chapter five gave conclusion and policy
recommendation

4|Page The impact of external debt on Ethiopian economic growth (2001-2021)

 CHAPTER TWO
2. REVIEW OF LITERATURE
This section includes both theoretical, empirical review and conceptual framework, the theoretical
literature explains the theoretical aspects of external debt and its impact on economic growth. The
empirical review focused on summarizing different study related with the study.

2.1. Theoretical literature

2.1.1. Contextual definition of External Debt
According to World Bank, external debt is that part of the total debt in a country that is owed to
creditors outside the country. The debtors can be the government, corporations or private
households. The debt includes money owed to private commercial banks, other governments, or
international financial institutions.

External debt, or foreign debt as it is sometimes called, factors in both principal and interest and
does not include contingent liabilities, which are debts that may be incurred at a later date based
on the outcome of an uncertain future event. It is defined by the International Monetary Fund
(IMF) as debt liabilities owed by a resident to a nonresident, with residence being determined by
where the creditors and debtors are ordinarily located rather than their nationality. In some cases,
external debt takes the form of a tied loan, which means the funds secured through the financing
must be spent in the nation that is providing the financing. For instance, the loan might allow one
nation to buy resources it needs from the country that provided the loan.

External debt, particularly tied loans, might be set for specific purposes that are defined by the
borrower and lender. Such financial aid could be used to address humanitarian or disaster needs.
For example, if a nation faces severe famine and cannot secure emergency food through its own
resources, it might use external debt to procure food from the nation providing the tied loan.
Likewise, if a country needs to build up its energy infrastructure, it might leverage external debt
as part of an agreement to buy resources, such as the materials to construct power plants in
underserved areas.

In general, External debt is the portion of a country's debt that is borrowed from foreign lenders,
including commercial banks, governments, or international financial institutions. These loans,

5|Page The impact of external debt on Ethiopian economic growth (2001-2021)

including interest, must usually be paid in the currency in which the loan was made. To earn the
needed currency, the borrowing country may sell and export goods to the lending country.

2.1.2. Classifications of external debt

Classifications of external debt can be made based on different perspectives. The majors are
borrowers, creditors and productivity of the debt.

MOFED (2014) classified External debt into three based on the perspective of borrowers

1. Public Debts: These are external obligations of a national or state government. In case of
Ethiopia, all external loans contracted between external creditors and MOFED.
2. Publicly – Guarantee Debts: These are external debts where repayment is guaranteed by
a government or by an entity of the public sector in the debtor country. In case of Ethiopia,
it comprises of loans contracted by public enterprise like EEPCO, and guaranteed by
MOFED as well as the state-owned bank- the commercial bank of Ethiopia (CBE).
3. Private – Non – Guaranteed Debts: These are external Obligations which are not
guaranteed for repayment by the government. Under Ethiopian case, it includes debt
contracted by public enterprise like EAL without government or government owned bank
guarantee.

External debt from the perspective of creditors has two major components.

1. Official Creditors: These include international organizations such as The World Bank
Group (which give multilateral loans), foreign governments and their agencies (which give
bilateral loans). Loans from these two sources usually come on ―sift‖ and concessionary
terms and have relatively longer-term maturity and low rates of interest.
2. Private Creditors: These include contractors, exporters, manufacturers or other suppliers
of goods and services hence there are contractor finance and supplier of credit.

Debts are also classified into two based on the uses they are put into:

1. Reproductive debt: this is raised for productive purposes and is used to add to the
productive capacity of the economy. These loans are utilized on development activities
like infrastructure development like roadways, railways, airports, power generation,
telecommunications etc. it is self - liquidating in nature, this means the principal amount

6|Page The impact of external debt on Ethiopian economic growth (2001-2021)

 and interest are normally paid out of the revenue generated from the projects to which the
loans were utilized.
2. Dead weight debt: An unproductive debt is one which does not yield any income. It does
not add to the productive assets of the country. Debts utilized to finance war and
expenses on current expenditures

2.1.3. Causes of external debt

The following are some causes for external debt especially in sub-Saharan Africa. Those are A.

Corruption and the mismanagement of resources by some leaders.

One of the most worrying causes of debt in Africa has been corruption and mismanagement of
resources.

B. Borrowing at high-interest rates to service debts

Borrowing to pay debts is one of the most disturbing causes of debt. This business of borrowing
to pay debt is known as the debt trap. Debt trap is indeed the vicious circle of taking international
or domestic loans to service a county’s debts. For most sub-sahran African countries, the reality of
high and rapidly increasing interest rates in the 1970s and 1980s had reached heights that were
simply unsustainable for their comparatively weak economies. This situation resulted in high
levels of default which compelled most of them to resort to borrowing in order to service their loan
payment obligations.

C. The oil price shocks and crisis

The Yom Kippur War of 1973 between Israel and a coalition of Egypt and Syria resulted in sharp
increases in oil prices globally from $ 3.00 to $12.00 per barrel. The Overseas Petroleum Exporting
Countries (OPEC) exploited the dependency of the western nations on oil, to boost the political
power on the international arena

A second oil shock occurred in 1979, caused by the outbreak of the first Gulf War between Iran
and Iraq. This war resulted in huge losses in the production, storage and distribution of oil that
pushed the prices of oil from $ 12 in 1973 to $ 39 per barrel in 1979. This sharp and unanticipated
increase pushed most non-oil producing African countries into debt, because it forced them into
the debt trap of borrowing to meet the oil consumption requirements.

7|Page The impact of external debt on Ethiopian economic growth (2001-2021)

 D. Declining revenue from the export of African primary commodities

For African countries whose incomes depended largely on the export of raw materials, natural
disaster, declining rainfall and unpredictability of prices worryingly increased their vulnerability
to debt. They have witnessed a worrying decline of about 50% in the prices for the export of their
primary exports commodities in the last 25 years.

In the case of coffee and sugar, this was due to overproduction and saturation of the markets.
Because of the unequal status within the international trade system, African countries have suffered
tremendous losses as a result of the ‘terms of trade’. The capitalist international system of division
of labour has assigned African countries the role of producers and suppliers of raw materials (like
cocoa, coffee, rubber, cotton, sugar cane, timber etc) whose prices have been falling steadily as
compared to the prices of manufactured goods.

E. Aid Dependency syndrome

The Aid dependency syndrome may well have contributed to the indebtedness of African countries
and their growing poverty levels. Aid can be classified into three main types:

1. Humanitarian or emergency aid:- given in response to natural disasters like fire, flood
or to earthquake victims
2. Charity-based aid:- which normally comes from non-profit organizations and foundations
countries hit by drought, famine, war, displaced people or refugees
3. Systematic multi-lateral aid: - which comes from the World Bank, Overseas
Development Agency.

Unfortunately the systematic aid packages have often failed in achieving their goals of providing
infrastructure, fighting poverty, disease, illiteracy and hunger, and building capacity for good
governance in Africa. Across the world, recipients of aid have become worse off. Aid has helped
to make the poor poorer and made growth slower because of the dependency syndrome trap. Sixty
years of three trillion dollars development aid to Third World countries, has little evidence of
significant effect on recipients in fighting poverty, disease, hunger, illiteracy, unemployment and
environmental degradation.

8|Page The impact of external debt on Ethiopian economic growth (2001-2021)

Western countries engaged with African countries depending on what benefits are at stake.
Western donor countries often turned a blink-eye on corruption and gross human rights abuses in
countries they depended on for their much-needed raw materials. Systematic aid was used as bait
in dealing with and winning the friendship of corrupt leaders in Africa, whose dealings with donors
have further worsened the debt profile of African countries.

F. Rising cost of imports for African countries

The rising cost of imports is another disturbing cause of debt to African countries. The rising cost
of imports like medicine, machinery, equipment, arms and ammunitions and other consumables
coupled with the decreasing export earnings of African countries has worsened the level of
indebtedness resulting in what has become known as the triangle of disaster – youth
unemployment, rural poverty and environmental degradation.

G. Changes in the International Capital Market

A major cause of the African debt problem was the oil boom and the changes it provoked on the
international capital market. The sharp and steady increase in the price of oil resulted in OPEC
amassing ‘petrol-dollars’ in private banks in search of investment opportunities. Most African
countries took advantage of these ‘petrol-dollars’ by taking more loans to undertake heavy
infrastructural projects. These loans which they did not have the capacity to service, eventually
increased their levels of indebtedness to the lending institutions.

Furthermore, the existence of the ‘petrol-dollars’ weakened the power of the industrialized western
countries to match the flow of funds to Africa with the capacity to pay; a function that was
traditionally played by the World Bank and the IMF. This lack of control provided African
countries the freedom of taking loans they were not in the position to service.

Finally, the deterioration of the Soviet-Union, the structure of development assistance to Africa
also changed. Industrialized countries diversified their aid to meet new demands from the former
Soviet-Union Bloc states in Africa.

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age The impact of external debt on Ethiopian economic growth (2001-2021)
 H. Rises in Interest Rates

The extensive and excessive armament activities of the Ronald Reagan Administration couple with
a tax-reduction policy in the US, induced investment recovery and change in the operating
procedures of the Federal Reserve’s monetary policy with tighter restraints that led to a sharp
increase in real interest rates and the value of the dollar. This development had a very devastating
effect on African countries interest payment and import bills.

2.1.4. External debt and future generation

What is the effect of debt burden (servicing) on macroeconomic performances and future
generations? In general, there are five views providing different submissions can be identified.
Those are:

2.1.4.1. The neo-classical model

This model assumes that individuals plan their consumption decision over the entire life cycle.
Borrowing increases present consumption and thereby shifts tax burden to the future generations.
This school of thought assumes full employment implying that increase in consumption decreases
savings, causing interest rates to increase in the capital markets to restore the equilibrium. The
higher interest rates in turn results in a decline in private investment. This crowding out effect
impedes the effectiveness of the government to influence the economy through fiscal policies
(Bailey, 1971; Buiter, 1977). The weakness of this theory is that very few economies especially in
Sub- Saharan Africa, including Kenya have not achieved even near full employment level.

2.1.4.2. The Keynesian model

This model brings forth a counter proposition by pointing out the multiplier effects of external debt
(Eisner, 1989). It suggests that increased external borrowing results in an increase in domestic
production, which boosts investor sentiments about the future path of the economy. Moreover,
borrowing implies investment in infrastructure, which could lead to a reduction in the cost of doing
business in future and hence benefits future generation. Keynesians also permit less than full
employment of resources and consequently, the government has to intervene in order to assure that
demand is sufficiently large so that labor demand rises; national income rises and approaches its
full employment level. In addition, according to that view public debt does not pose a problem if
the government runs into debt in the home country. They further argued that debt finance was

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age The impact of external debt on Ethiopian economic growth (2001-2021)
necessary to ensure an adequate level of aggregate demand because savings cannot be fully
absorbed by private investments. In addition, the Keynesians took up the position originally held
by Ricardo that the burden of public debt is completely shouldered by the generation that issues
the debt. This view can be summarized by the phrase we owe the public debt to ourselves.
‘‘Government budget deficits and hence rising government debt do not, therefore, pose particular
problems: they are not harmful, and they are desirable in times of low aggregate demand and high
unemployment to restore the full-employment equilibrium.

2.1.4.3. The Ricardian Equivalence theory

According to this theorem, the society‘s burden from the government spending is brought about
by the wastage use rather the source of financing the expenditure. Therefore, it does not matter
how the funds are raised through taxation or by borrowing loans. If the current expenditure is
financed through borrowing, this reduces the amount of taxes to be paid by the current generation.
Future taxation will be much higher to repay, this means that the disposable income in future will
reduce (Contessi, 2012). 14 The burden of tax is postponed rather than being reduced. If the
population is aware that the tax burden will increase in future, they are more likely to increase the
level of consumption but not save or make an investment that is equivalent to the amount of
reduced tax. Government debt is seen as an equivalent to future taxes since there is no crowding
effect of capital and consumption by the population and hence debt neutral to growth. National
government may finance its expenditures through taxes or issuance of bonds. Bonds in this case
are loans; this is repaid by raising adequate taxes in future. The decision is therefore tax now or
later. For instance, if the government finances extra spending through deficits that is borrowing
now to pay later, the tax payers will prospect of having to pay higher taxes in the future. This will
lead to an increase in their savings to make pay for future tax which in turn mitigate their current
consumption, however, the effect on the aggregate demand will be the same if the government was
to choose tax now (Cameron and Trivedi, 2005).this theory as advanced by Barro (1974) argues
that increase in borrowing must be paid for, either now or later. Therefore, a reduction in current
taxes must be matched by an increase in future tax burden to repay the debts, leaving interest rates
and consequently private investments essentially equivalent. Government finance is therefore
irrelevant (Ricardo, 1942). However, this model is critical due to the planning horizon of
individuals which is not long enough, an assumption in this model.

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age The impact of external debt on Ethiopian economic growth (2001-2021)
 2.1.4.4. Modigliani model
This model claims that either future or current generation may bear the burden of external debt
based on the purpose borrowed money put for. The future generation certainly bears a burden if
the money borrowed is used to finance current consumption because its consumption level is
reduced by an amount equal to the loan plus the accrued interest that must be sent to foreign lenders
(Modigliani, 1961). If, on the other hand, the loan is used to finance capital accumulation, the
outcome depends on the project‘s productivity. If the marginal return on the investment is greater
than the marginal cost of funds obtained abroad, the combination of the debt and capital
expenditure actually makes the future generation better off. To the extent that the project‘s return
is less than the marginal cost, the future generation is worse off. Tax burden might be offset in
part, totally or more than the offset if there is an increase in debt, which leads to an increase in the
public expenditure that leads to an increase in the real income of the future generation through
channels such as gainful public investments and productity (Modigliani, 1961).

2.1.4.5. Intergenerational model

Two models categorized under this are overlapping generation and Lerner models. The former
model defines a generation as everyone who was born at about the same time. Hence at any given
time several generations coexist simultaneously. The model assumes no private savings (everyone
consumes their entire income) and the situation is expected to continue forever. In this model, the
population consists of equal number of the young, middle-aged and old people. The burden of a
debt can be transferred across generations; the old age passes the burden to the middle-aged and
the middle-aged to the young. The internal external debt distinction that is vital in Lerner‘s model
is irrelevant here; even though the debt is all internal, it creates a burden for the future generation.
By comparing the net taxes paid by different generations, one can get a sense of how government
policy redistributes income across generations. The overlapping generation‘s model does not allow
for the possibility that individuals in a given generation may care about their descendants as well
as themselves. This intergenerational model discussed do not allow for the fact that economic
decisions can be affected by government debt policy, and changes in these decisions have
consequences for who bears the burden of the debt. Instead, it is assumed that the taxes levied to
pay off the debt affect neither work nor savings behavior. If taxes distort these decisions, real costs
are imposed on the economy. More importantly, they ignore the potentially important effect of
debt finance on capital formation.

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 2.2. Empirical Literature
A number of research related to the external debt impact on economic growth have been done both
in Ethiopia at country level and outside it at international level. The result from the studies showed
both positive and negative effects of external debt on economic growth. Some of these studies are
stated at both case:

2.2.1. Related Studies in the Rest of the World

Tokunbo (2006) studied how the use of budget deficits as an instrument of stabilization leads to
the accumulation of external debt with the attending effects on growth in Nigeria between 1970
and 2003.By synthesizing a relationship between budget deficits and external debt the study shows
the implications on economic growth of conducting a fiscal policy within the contexts of debt
stabilization and debt sustainability.

Michael & Sulaiman (2012) in Nigeria examined the impact of external debt on economic growth
and investment by adopting the debt Cum-Growth model along with multiple regression technique.
From the results, they conclude that there was existence of a positive relationship between external
debt, economic growth and investment.

Utomi O. (2014) studied the impact of external debt on economic growth in Nigeria for period
1980-2012 using time series data on external debt stock and external debt service to capture fordebt
burden both in the long run and short run. The study used techniques including augmented dickey
fuller (ADF), Test for johasen integration, VECM AND GCT. The results showed statistically
insignificant long run relationship and bidirectional relationship between external debt and
economic growth in the Nigeria.

Kangara (2015) investigated the effect of national debt on economic growth of Kenya using data
from 2005-2014 .The study employed a regression model, descriptive statistics and correlation
analysis to analyze the data. The conclusions of the study reveal that a national debt is negatively
related to economic growth in Kenya –which implies the increase in national debt negatively
impacted the economy of the country. The results indicated that net exports and consumption
contributed positively to GDP; however, an increase in national debt, interest rates and inflation
are found to have negative effect on GDP.

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 2.2.2. Related studies in Ethiopia
Befekad (1992) studied the impact of foreign debt on economic growth of Ethiopia using the data
from1964-1984, and found that long-term external debt has had a positive impact on the economy.
While in the pre-revolution period and the early post-revolution years the relationship is positive,
it turned negative during the post-revolution era. However, the post-revolution performance cannot
be attributed to foreign debt. Rather, the problem was one of inappropriate domestic policies. The
regime's policy of curtailing private-sector economic activity, coupled with its own, not only
limited, but grossly inefficient utilization of resources, failed to take full advantage of the existing
infrastructure. The lesson one draws from the Ethiopian experience is that while external factors
could be contributory, major responsibility seems to lie in domestic factors. The main stumbling
block in the Ethiopian case is found to be the policy of the government.

Hana Argaw (2013) investigated the impact of external debt on economic growth of Ethiopia
employing macroeconomic model estimated for 2000-2010.The empirical findings reveal that
external debt does not have effective on economic growth. The result indicated that both debt
service payment and foreign exchange reserve have positive relationship with growth gross
domestic product of the country, rather than depressing it and hence the study confirms that there
is no sign of debt overhang which negatively affects economic growth of country.

Mulugeta (2014) empirically studied the impact of external debt on economic growth in Ethiopia
to determine the existence of a debt overhang and/or crowding out effects using time series data
for the period 1983/84 to 2012/13. The Johansen Maximum Likelihood approach was used to test
for a long-run relationship among the variables and Vector error correction model (VECM) used
to estimate the short run impacts. The empirical result suggests the existence of long run
relationship between real GDP and external debt. The results of the study reveal that real GDP is
influenced negatively by the past stock of external debt and debt servicing and, positively by the
current external debt inflows. This was indicating the existence of debt overhang problem and
crowding out effect in Ethiopian economy.

Wessene (2014) examined the long run and short run relationship between external debt and
economic growth in Ethiopia over the period of 1970/71-2010/2011 using Autoregressive
Distributed Lag Model (ARDLM) or bound testing approach. The empirical results indicated that
the relationship between external debt and economic growth both in the short run and long run is

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age The impact of external debt on Ethiopian economic growth (2001-2021)
significant with a negative sign. This indicates the existence of a debt overhang problem in the
country. But the debt servicing variable has a negative but insignificant effect on economic growth.
Moreover, there exists unidirectional causality from external debt to economic growth. Therefore,
external debt is found to have a negative effect rather than causing economic growth in Ethiopia
for the period under study. Hence, in order to tackle the problems of external debt, there should be
close monitoring and consistent debt management strategies so as to avoid the misallocation and
mismanagement of external debt.

To conclude the theoretical and empirical Literature, there are several contextual definition,
according to World Bank external debt is defined that part of the total debt in a country that is
owed to creditors outside the country. The classifications of external debt can be made based on
different perspectives like MOFED (2014) classified External debt into three based on the
perspective of borrowers those are public debt, Publicly – Guarantee Debts and Private – Non –
Guaranteed Debts. External debt also have impact on future generation which discussed above
with 5 different views. Further, Empirical studies on determining external debt on Ethiopian
economic growth shows negative sign to GDP. However, external debt servicing has negative
impact but some studies show it has positive impact to GDP. Economic growth as reviewed the
above literature is determined by debt indicators (stock of external debt and external debt
servicing), inflation, exchange rate and foreign aid.

2.3. Conceptual framework

In this conceptual framework, indicates the relationship of dependent variable and independent
variable. The dependent and independent variable relationship has been developed based on the
above theoretical and empirical literature review.

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 FIGURE 1: CONCEPTUAL FRAME WORK

Crowding out effect Debt overhang effect

Debt servicing Stock of debt

Debt Indicators

Real gross domestic product

Inflation Movement of real

Real gross capital Active labour force
exchange rate
formation

To know macro
economic condition

Source: own construction (by taking the theoretical and empirical review)

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age The impact of external debt on Ethiopian economic growth (2001-2021)
 CHAPTER THREE

3. METHODOLOGY OF THE STUDY

This section provides a blueprint for directing a research and outlines framework to investigation
the impact of debt on economic growth of Ethiopia in a given time period. In particular the chapter
provides technical approaches that the researcher adopted in model selection to answer the research
questions and to meet the objectives. The chapter basically focuses on how the entire study will be
done. Issue such as data types and sources, definition of variables, model specification, and
estimation procedures and techniques are covered.

3.1. The data set

3.1.1. Data Type and Source
The type of data which is applicable for the study is time series which are secondary in their nature.
An attempt that will gather 20 years data on some important variables. The data covers the period
between 2001 and 2021. These data are obtained from different sources: such as World Bank (WB)
and central statistical agency (CSA). The debt indicator (like stock of external debt and debt
servicing) data would draw from national bank of Ethiopia (NBE) and the data (like real gross
capital formation, Labor force, real exchange rate and inflation) would be gather from World Bank
(WB).

3.1.2. Data Analysis

The data analysis and estimation will employ both descriptive analysis and an econometric model
which employ ordinary least square (OLS) multiple regression models. To estimate the model and
to examine the statically significance of the explanatory variables, time series data were employed
from 2001 to 2021. The statistical software package uses the econometric analysis will be STATA
14 and EVIEWS10.

3.2. Model specification

Conceptually, model specification refers to the determination of which independent variables
should be included in or excluded from a regression equation. This study is based on augmented
Harrod-Domar and dual gap model as the latter is an extension of the former one. The H-D growth
model provides the simplest possible framework within which the relationships among the
aggregate macro variables can be examined.

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The basic H-D model can be summarized as follow:
Yt = Ct + St…………………………………………. (4.1)

Where; Yt = GDP, Ct = Consumption and St = saving

Equilibrium in the simple economy requires It = St; thus, equation (4.1) changes to

Yt = Ct + It …………………………………….. (4.2)

Within the Harrod Domar framework the growth of real GDP is assumed to be proportional to the

share of investment spending (I) in GDP and for an economy to grow, net additions to the capital

stock are required. The evolution of capital stock overtime is given as

K t+1 = (1 –σ)Kt + It …………………………..(4.3)

Where; Ϭ is the rate of depreciation of the capital stock. The relationship between the size of the
total capital stock(K) and total GDP(Y) is determined as the capital output ratio (K/Y, it also
follows that V= ∆K/∆Y where ∆K/∆Y is the incremental capital output ratio, or ICOR). If we
assume that total new investment is determined by total savings and total saving is some proportion
of GDP (St= sYt), then the essence of the H-D model can be set out as follows, since K = VY and
It = St, it follows that we can rewrite equation (4.3) As:

VYt +1 =(1-σ)vYt + sYt………………………….(4.4)

Yt +1 – Yt = (S/V-Ϭ)Yt…………………………..(4.5)

(Yt+1 – Yt)/Yt = (S/V-Ϭ)………………………… (4.6)

Where,( Yt+1 – Yt)/Yt is growth rate of GDP and substituting it by G then,

G= S/V –Ϭ…………………………….………. (4.7)

Depreciation (Ϭ) is considered to be constant and can be ignored, so

G=S/V…………………………………………… (4.8)

The model shows that output and capital formation are linearly related. That is, when there is more
capital stock, the higher would be the growth of economy. From the outset, the Horrar Domar

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age The impact of external debt on Ethiopian economic growth (2001-2021)
model was used to calculate the amount of finance required to bridge the gap between the available
savings and the required amounts that must be channeled to investment to bring about the targeted
growth rate (Easterly,1998). This implies, in the H-D model, constraints on savings is the binding
limit to growth. That is, when domestic savings alone are inadequate to bring about the investment
level necessary to attain the targeted growth rate, then growth is said to be constrained by the
saving gap. The role of foreign finance, which includes external debt, in this regard is to augment
domestic saving rates to achieve the targeted growth.

Dual gap includes the gap between the import and export as well in addition to saving gaps as other
factor limiting growth. This approach is based on the assumption that all investment goods are not
produced locally. That is, some level of capital import is necessary in order to achieve the desired
investment level. When foreign exchange earned through export are insufficient, actual import will
be lower than the level required achieving a targeted growth rate. Thus, the role of foreign inflow
here is to finance the import bill left uncovered through export earnings so as to achieve the targeted
growth rate. This approach got emphasis since developing countries depend on imported capital
goods and intermediate inputs. In this model, both gaps represent independent limit to growth
where inflow of foreign fund is used to fill gaps (Chenery and Strout, 1966) The model is coined
from a national income accounting identity which states that excess investment expenditure over
domestic saving is equivalent to the surplus of imports over exports.

Thus, at equilibrium the following identities held;

I – S = M – X …………………………………… (4.9)

S – M = X – M ………………………………….. (4.10)

Where, I= investment, S= saving, M=import, X= export

The equations (4.9 and 4.10) show that the domestic resource gap(S-I) is equal to foreign exchange
gap(X-M). An excess of import over export implies an excess of resource used by an economy
over resources generated by it. This further implies that the need for foreign borrowing is
determined overtime by the state of investment in relation to domestic savings.

Following the above theoretical relationship of foreign borrowing and economic growth,

Can be augmented with debt indicator as

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age The impact of external debt on Ethiopian economic growth (2001-2021)
Yt = F(EDGDP, DSR)……………………………(4.11)

Where, EDGDP = stock of external debt to GDP ratio, DSR= the debt service as ratio of export
Earnings. These variables represent external debt indicators of the nation. However, the level of
capital formation alone does not guarantee growth as postulated by the H-D model.

The empirical model is specified on the basis of the theoretical model explained above part taking
into account other variables that are believed to be important in describing the model better in the
context of the country under study, Ethiopia. Moreover, the model is preferred based on its
relevance and availability of data. The original model is borrowed from Elbadawi et al (1996)
studies on the debt burden and production function after making adjustment to reflect Ethiopian
conditions. The model will apply OLS estimation method because of its convenience and
simplicity.

Therefore, the mathematical regression equation is:

RGDP = F(EDGDP, DSR, RER, INV, INFL, LLFP)

Then the econometric equation is formulated as follows:

RGDPt = β0 + β1EDGDPt + β2DSRt + β3INVt + β4INFLt + β5RERt + β6LLFPt + Ut

Where, β0, β1 … β6are parameters to be estimate the model.

RGDPt = Real Gross Domestic Product

EDGDPt = Stock of external debt to GDP ratio

DSRt = the debt service as a ratio of export earning

INVt = Real gross capital formation

INFLt = Rate of inflation (reflects macro-economic stability)

RERt = Movements in real exchange rate

LLFPt = Active labor force as percentage of total population Ut = the error term

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age The impact of external debt on Ethiopian economic growth (2001-2021)
 3.3. Definition of variables
3.3.1. Dependent Variable
Real gross domestic product (RGDP) is used as a proxy variable to measure economic
growth in the country. It is represented by the country‘s total output at constant price per
birr.

3.3.2. Independent variable

❖ Total external debt stock is used as percentage of GDP. It indicates the impact of
external debt on the economy and it measures the indebtedness of the country in the given
period of time. External debt does not necessarily imply slower economic growth, rather if
only the country became unable to meet its external debt obligations that it would pose a
risk to economic prosperity and leads to debt overhang (Shabbir, 2013). Therefore, we also
expect that β1 will be negative.
❖ Total debt service, the sum of both principal and interest payment. It is also used as
percentage of export of goods and service. It shows the debt burden of the country and tries
to capture the crowding out effect. The debt crowding out effect is also studied by different
researchers like Krugman (1988) and sachs (1989). This is the case when indebted poor
countries transfer resources, including foreign aid and foreign exchange resources to
service their accumulated debt. The equivalent ratio which can trap the crowding out effect
is the total debt service export ratio. The study expects a negative impact of the ratio on
economic growth (WB, 2010). The empirical findings result indicated that both debt
service payment and foreign exchange reserve have positive relationship with growth gross
domestic product of the country (Hana Argaw, 2013) Therefore, the expect sign of β2 will
be indeterminate.
❖ Capital Formation: Capital means the stock of physical reproducible factors of
production. When the capital stock increases with the passage of time it forms capital. An
increase in the rate of capital formation raises the level of national income. The process of
capital formation helps in raising national output which in turn raises the rate and level of
national income. Elizabeth et al (2011) investigated that capital formations has a significant
positive impact on economic growth. Therefore, the expected relationship between GDP
and capital formation will be positive or the sign of β3 will be positive

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age The impact of external debt on Ethiopian economic growth (2001-2021)
 ❖ Inflation: measures how much more expensive a set of goods and services has become
over a certain period, usually a year. Due to inflation, GDP increases and does not actually
reflect the true growth in an economy. This is why the GDP must be divided by the inflation
rate to get the growth of the real GDP. Thus, between GDP and inflation rate, a reverse
statistical correlation exists. As the inflation ratio is higher, the value of GDP in real terms
decrease. We also expect that β4 will be negative.
❖ Exchange rate: is how much of one currency can be bought for each unit of another
currency. A currency appreciates if it takes more of another currency to buy it, and
depreciate if it takes less of another currency to buy it. The exchange rate is one of the
important factors that influence the GDP of the economy. Exchange rate and foreign
currency exchange reserves are highly correlated which influence the GDP a lot (pramanik,
subhajit, 2021). Therefore, the expected sign of β5 will be positive.
❖ Active Labour force: or currently active population, comprises all persons who fulfil the
requirements for inclusion among employed (civilian employment plus the armed force) or
the unemployed. Additionally, holding productivity per worker constant, an increase in the
share of adults who are working through a rise in the labour force participation rate will
directly increase GDP per capita. However, some arguments indicate that labor force of
LDCs negatively affects growth due to unskillfulness and inefficiency of them (Todaro,
1994). This might be true for Ethiopia, and hence it is difficult to predetermine the expected
sign.

3.4. Economic estimation procedures

For any given time, data output serve for policy recommendation from derived concussion and it
is mandatory to pass via three stages estimation of techniques. Each of which of any or other way
tests the stationary of time series variable. The commuting of error in each stage cannot permit
progress into the next stage unless the data are adjusted in away to fulfill criteria of that particular
stages of estimation techniques requires.

3.4.1. Unit Root Test

The data is checked whether it is stationary or not before conducting any economic study. If the
variables under study are non-stationary, then may leads to spurious result so it is important that
the series of data is stationary. That is its mean and variances are constant that over times and the

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age The impact of external debt on Ethiopian economic growth (2001-2021)
value of covariance between two time periods and not on the actual time at which covariance is
computed (Gujarati D.N, 2004). In time series econometric time series has a unit root is known as
random walk time series (Green, 1990). A random walk is an example of non-stationary time
series. Augmented Dickey Fuller (ADF and) Phillips Peron (PP) tests are the two ways of checking
unit root tests. For passing decision whether a given data is stationary or not compared ADF with
the computed absolute value of “t” statistics i.e., if “t” statistics or calculated exceeds “t” critical
or tabulated, we can reject the null hypothesis that says unit root is exist or non-stationary meaning
we can say that unit root is not exist then the series is stationary. But if “t” calculated is less than
“t” tabulated we cannot reject the null hypothesis and then the series is stationary. The formula of
this ADF test is as follows

∆RGDPt=β0+β1RGDPt- +εi …………………. ADF Stationarity

Phillips and Peron also use non parametric statistical methods to take care of the serial correlation
in the error terms without adding lagged difference terms.

3.4.2. Co-integration Test

After checking for unit root tests, the test of co-integration can be performed. Co-integration test
tells about whether there is long term relationship between the variables or not. The pre-request of
applying this test is to first check for unit root so that it is decide whether the series is stationary or
not. To find out RGDPt= β0 if two or more-time series are co-integrated, Gujarati put two methods:
Engle-Granger (EG) or Augmented Engle-Granger (AEG) test and co-integration regression on
Durbin Watson (CRDW) tests. In regarding to the decision rule, the same rule DF or ADF unit
root test is applied to EG or AEG test. Accordingly, if the calculated “t” value in absolute value
exceeds the EG 1%, 5%, and 10% critical value, then the time series variables are co-integrated.
This test is formulated as follows

RGDPt + εi …………………………. Long run Co-integration

Where, εi=error term, β0……. βi = parameters, Xi =explanatory variables in the model Finally,

the model becomes:

RGDPt = β0 + β1EDGDPt + β2DSRt + β3INVt + β4INFLt + β5RERt + β6LLFPt + εi

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From this model regression predict the residual term (ECM) which is subject to unit root analysis
and find that it is stationary; that is it is I(0).

3.4.3. Error Correction Model

The error correction mechanism is a means of reconciling the short run behavior of an econometric
variable with its long run behavior. It is believed that economic variables are co-integrated when
they establish along run equilibrium relationship between variables involved. But there may be
exist disequilibrium in the short run. Therefore, in this case one treats the errors term of regression
equation as the “equilibrium error” and this error term can be used to smooth the short run behavior
of a given time series variable to its long run behavior.

DRGDPt + αECM_1+ei ………………. short run

Even though those pre-estimation tests are mandatory, we also undertake some post-estimation
tests including, multicollinearity test, Heteroscedasticity, normality test, and auto correlation test
to make our findings more robust.

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 CHAPTER 4

4. DATA PRESENTATION AND ANALYSIS

This chapter focused on the results of the study that the researchers investigated both in the longrun
and short-run. The analysis used descriptive and inferential statistics. Descriptive statistics like
mean, standard deviations, minimum value, maximum value, and standard deviation and table
used. Inferential statistics applied using ARDL model test co-integration by error correction bound
test, VECM, diagnosis test and sensitivity tests are conducted.

4.1. Descriptive Statistics

Before estimating the data, it's important to describe the properties and the behavior of the study
variables. It is useful to take some corrective measures so that the variables are certainly applicable
for the estimation process. The result given in the table below describes some behavior of the
variables.
variables observations mean median Std. dev. minimum maximum
RGDP 21 96.04555 82.62810 57.41999 1.3456 219.9289
EDGDP 21 35.73571 29.58602 21.8989 10.51625 84.43963
DSR 21 12.35528 8.062594 8.445988 2.793224 28.53743
INV 21 351361.4 164525.7 380913.6 18468.05 1216585
INFL 21 3.560193 3.269115 1.326016 0.8216381 6.660082
LLFP 21 85.56754 85.62743 0.4335067 84.88136 86.15302
Table 4.1 summary of descriptive analysis

From table 4.1, the real gross domestic product had a mean 96.04555 and standard deviation
57.41999 with the maximum value 219.9289 and minimum value 1.3456. The Stock of external
debt to GDP ratio under the study had a mean of 35.73571 and the standard deviation of 21.8989
with a minimum and maximum of 10.51625 and 84.43963 respectively. The debt service as a ratio
of export earning had a mean of 12.35528 and a standard deviation of 8.445988 with the minimum
value of 2.793224 and a maximum value of 28.53743 for the period under study. Rate of inflation
had a mean of 3.560193 and a standard deviation of 1.326016 with a minimum of -0.8216381 and
a maximum of 6.660082. Gross capital formation had a mean of 351361.4 and a standard deviation
of 380913.6 with a minimum and maximum value of 18468.05 and 1216585 respectively. Finally,
the mean of Active labour force was 85.56754 and a standard deviation of 0.4335067 with the
minimum value of 84.88136 and a maximum value of 86.15302 for the period under study.

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The standard deviation shows how much dispersion exists from the average value. Except gross
capital formation a low standard deviation indicates that the data point tend to be very close to the
mean, whereas gross capital formation has high standard deviation indicates that the data point
are spread out over a large range of values. As shown in the summary statistics, all have low
standard deviation (except gross capital formation). This shows stability in the long run
relationship between real gross domestic product and its determinant factors.

4.2. Empirical Analysis

4.2.1. ADF Unit Root Testing Result
Before conducting the simultaneous tests, the variables must be found to be individually stationary.
The augmented Dickey Fuller (ADF) test is applied here to determine the existence of a unit root
test. This test is basically has been used for its consistency, accuracy and resourcefulness. The table
below shows the result of ADF test of variables under consideration at level.
VARIABLES ADF t-statistic in level AFD t-statistic in First Unit root
Difference
Intercept Intercept and Intercept Intercept and
trend trend

RGDP -2.612565 -2.766952 -5.971664* -6.256782* 1

EDGDP -6.471501* -5.634289* -2.880077*** -2.830689 0
DSR -0.846366 -3.764037** -4.612071* -3.940409** 1
INV 5.491701 1.138665 0.538865 -9.088484* 0
INFL -3.348221** -3.555507*** -5.199070* -4.987180* 0
LLFP -1.685980 -6.893717* -3.016040*** -1.779153 1
* 1% 0 stationary at level
** 5% 1 stationary at first difference
*** 10%

Table 4.2 Results of unit root test

As shown in the table above, augmented Dickey-Fuller and tests the variables Stock of external
debt to GDP ratio (EDGDP), real gross capital formation (INV) and Rate of inflation (INFL) are
stationary at level. Whereas, = Real Gross Domestic Product (RGDP), the debt service as a ratio
of export earnings (DSR) and Active Labor force as percentage of total population (LLFP) are
stationary at first difference. This implies the series are mixed order for the given time series, the

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ARDL methodology is quite appropriate to be adopted. This gives the stepping stone for the next
co-integration analysis and error correction estimation that may proceed to the existence of
cointegration

4.2.2. Co-integration
Co-integration is the formal statistical justification of the existence of this relationship among the
variables for the long-run equilibrium. Hence, after determining the stationary nature of the
variables, the next task in the bounds test approach of co-integration is estimating the specified
ARDL model using the appropriate lag-length selection criterion. According to Pesaran and Shine
(1999), as cited in Narayan (2004)for the annual data, they recommended choosing a maximum of
two lag lengths but for small data, it is advisable to use 1 lag because when the lag length increases,
the observation fail to show the appropriate long run relationship among variables. Accordingly,
under the study period, co-integration (a long run relationship) is witnessed between real gross
domestic product and the given set of determinants considered and shown as follows:
Pesaran/Shin/Smith (2001) ARDL Bounds Test
H0: no levels relationship
Test Statistic Values K
F-statistic 6.108 5
T-statistic -5.612 5
Critical Value Bounds for F-statistic
Significance I0 Bounds I1 bounds
10% 2.26 3.35
5% 2.62 3.79
2.5% 2.96 4.18
1% 3.41 4.68
Critical Value Bounds for T-statistic
Significance I0 Bounds I1 bounds
10% -2.57 -3.86
5% -2.86 -4.19
2.5% -3.13 -4.46
1% -3.43 -4.79
Table 4.3 BOUND TESTING FOR CO-INTEGRATION

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age The impact of external debt on Ethiopian economic growth (2001-2021)
From the above table, the F-statistics value (6.108) is greater than I1 series at a 1% level of
significance. Then, we can’t reject null hypothesis. That means there is co-integration. And the
Tstatistics value (-5.612) is below I1 series at a 1% level of significance. Therefore, there is
cointegration or long-run relationship among the variables. Thus, the bound test shows there is
cointegration among the variables. In other words, there is a systematic relationship that
functionalizes the variables to form a linear stationary process that adjusts to the long-run after any
shocks or deviation of the short-run.

4.2.3. Diagnostic Tests

4.2.3.1. Multicollinearity test
It refers to when explanatory variables are highly interrelated. Variance inflation factor can be
employed to detect this problem. For this study it is tested both at level and after transforming the
variables by taking first difference for each variable. Table shows the results of VIF
VARIABLES EDGDP DSR Gross Capital Labour force Inflation
VIF 2.51 7.77 6.20 6.08 1.53
1/VIF 0.398115 0.128675 0.161388 0.164400 0.654690
Mean VIF 4.82

Table 4.4 Tests for multicollinearity problem

The data has no multicollinearity problem as mean of VIF is 4.82 which is far less than 10

4.2.3.2. Auto-correlation test

This assumption states that; disturbance terms is that the covariance between the error terms over
time (or cross-sectionally, for that type of data) is zero. In other words, it is assumed that the errors
are uncorrelated with one another. Autocorrelation test is conducted by applying Durbin-Watson
Test (d-statistics) and Breusch-Godfrey Serial Correlation LM Test. The area in which we do not
reject null hypothesis and decide that we do not have autocorrelation problem in the model is if the
Durbin Watson value is located between 4-dL and 4-dU.The differenced regression result of the
model shows, Durbin Watson statistics value is 2.190106 which is clearly located between dU and
4-dU. Therefore, based on the result there is no autocorrelation. The BG test (at 2 lags) which is
shown in the below table clearly presents the absence of autocorrelation hence null hypothesis
cannot be rejected even at 10% critical value.

lags(p) chi2 df Prob > chi2

2 1.864 2 0.3938

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age The impact of external debt on Ethiopian economic growth (2001-2021)
 H0: no serial correlation

Table 4.5 Tests for Auto-correlation problem

4.2.3.3. Heteroskedasticity test

It is assumed that the variance of the errors is constant, σ2 this is known as the assumption of
homoscedasticity. If the errors do not have a constant variance, they are said to be
Heteroscedasticity. The study uses Breusch-Pagan-Godfreytest for Heteroscedasticity. The null
hypothesis of this test is homoscedasticity or constant variance. With the level of significant 5%,
the p-value should be greater than 5% to conclude that there is no Heteroscedasticity problem.
Breusch-Pagan / Cook-Weisberg test for heteroskedasticity

Ho: Constant variance

Variables: fitted values of RGDP

chi2(1) = 0.74
Prob > chi2 = 0.3894

Table 4.6 Tests for heteroskedasticity problem

Above result there is no heteroskedasticity in the data since Chi is relatively small and p-value is
greater than critical at 5% level.

4.2.3.4. Model specification test

Model specification test is a way of detecting whether there is model specification bias or not due to
irrelevant variables, omitting relevant variables or adopting wrong functional form etc. Ramsey has proposed
a general test of specification error called RESET (regression specification error test) and it is applied here.

Ramsey RESET test using powers of the fitted values of RGDP

Ho: model has no omitted variables

F(3, 12) = 0.96
Prob > F = 0.4428

Table 4.7 Tests for Model specification problem

Taking the p-value 0.4428 greater than 5%, we can’t reject the null hypothesis of there is no omitted
variable in the model. Hence, the model is correctly specified.

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age The impact of external debt on Ethiopian economic growth (2001-2021)
 4.2.3.5. Normality test
This is to test whether data is normal distributed or not, and Skewness and kurtosis normality test
is used for this purpose. Ho: the data is normally distributed
Variable obs Pr(Skewness) Pr(Kurtosis) adj chi2(2) Prob>chi2
RGDP 21 0.4613 0.9913 0.57 0.7525
EDGDP 21 0.0175 0.4009 5.92 0.0518
DSR 21 0.2607 0.0522 4.98 0.0828
Inflation 21 0.3514 0.3463 1.95 0.3767
Gross Capital 21 0.0475 0.9836 4.16 0.1249
Labour force 21 0.6983 0.0827 3.57 0.1681
Table 4.8 Tests for Normality test problem

The null hypothesis cannot be rejected for all variable at 5% level, and hence all are normally
distributed.

4.3. Model Stability Testing Result

After the entire short-run and long-run estimation, model or parameters stability is tested.
Commonly, the stability of the model for long run and short run relationship is detected by using
the cumulative sum of recursive residuals (CUSUM) and cumulative sum of squares of recursive
residuals (CUSUMSQ). Cumulative sum of recursive residuals (CUSUM) helps as to show if
coefficients of the parameters are changing systematically and the cumulative sum of squares of
recursive residuals (CUSUMSQ) tests is useful to indicate if the coefficient of regression are
changing suddenly. We accept the null hypothesis of the parameter instability if the blue line cross
redline which is critical line and never returns back between two critical line and we reject the null
and accept the alternative there is parameter stability in the short run and long run if the cumulative
sum goes inside the area (can returns back) between the two critical lines.

FIGURE 2: PLOT OF CUMULATIVE SUM OF RECURSIVE RESIDUALS

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age The impact of external debt on Ethiopian economic growth (2001-2021)
 CUSUM lower
upper

0 0

2008 2021
year

Source: own computation using STATA14

FIGURE 3 PLOT OF CUMULATIVE SUM OF SQUARES RECURSIVE RESIDUALS

CUSUM squared

2008 2021
year

Source: own computation using STATA14

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age The impact of external debt on Ethiopian economic growth (2001-2021)
 4.4. Error Correction Estimation Result
After confirming the existence of long-run co-integration relationship among the variables, the
next step is running the appropriate ARDL model to find out the long-run and short-run
coefficients. Hence, error correction model estimation for both the short-run and long-run
coefficients simultaneously presented in table below. Besides, the model passes all the post
estimation diagnostics tests including the normality, heteroscedasticity, serial correlation, model
specification, and model stability. In addition, the estimation results show that the estimated model
has good fit (R2 = 0.9965). The coefficient estimate for the error correction term is the lagged
dependent variable and the short-run dynamics are captured by the first differenced variables while
the long run is captured by level variables in the error correction model.

VARIABLES ADJ LR SR
RGDP -.2440369***
(0.1565048)

EDGDP -7.374097***
(0.4616049)
DSR 2.141406*
(0.8414179)
INV 0.0000909**
(0.0000241)
LLFP 1.80695***
(0.7639338)
INFL -15.63014***
(0.9257269)

D.EDGDP -8.920132***
(0.8042764)
D.DSR 2.067396
(2.459648)

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age The impact of external debt on Ethiopian economic growth (2001-2021)
 D.INV -0.0004643**
(0.0001364)
D.LLFP -1.559369
(0.7523388)
_cons -6.566168***
(0.4759623)
F( 14, 4) = 80.75
Prob > F = 0.0003
R-squared = 0.9965
Adj R-squared = 0.9841
Log likelihood = -49.106672
Root MSE = 6.9915
*** p < 0.01, ** p < * p < 0.1
0.05,
TABLE 4.9 ERROR CORRECTION ESTIMATION RESULT

Table 4.9 revealed the speed of adjustment to restore equilibrium in the dynamic model. The ECM
coefficient demonstrates how variables quickly approach to equilibrium; in fact, it is theoretically
expected to have a negative and statistical significance coefficient. The model have negative signs,
as expected and confirms the existence of co-integration among variables at 1% level of
significance. Furthermore, a high statistical significance error correction term confirms that the
variables have stable long-run relationship. The error correction coefficient ECM-1 is - 0.244. This
indicates that the deviation in the short-run equilibrium narrows to the long-run equilibrium at a
speed of 24.4 percent per year. The constant has a negative significant coefficient of 6.566168 with
a P- value of 0.001 hence in our case significant at 1% confidence level. The estimated results
show that R2 and adjusted R2 of 0.9965 and 0.9841 respectively. This signifies that 99.65 percent
of the variations in real gross domestic product is explained by the independent variables. High
value of R2 indicated that the independent variables (Stock of external debt to GDP ratio, the debt
service as a ratio of export earning, Real gross capital formation, Rate of inflation and Active
Labor force as percentage of total population) succeed to Real Gross Domestic Product

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age The impact of external debt on Ethiopian economic growth (2001-2021)
Long run result

According with previous empirical studies in Ethiopia, on macroeconomic side, most of the
explanatory variables have their expected signs in the long run. In this study, the estimation result
reveals that the Real gross capital formation and Labor force as percentage of total population are
found to have a positive and significant effect on to Real Gross Domestic Product in the long run
whereas Stock of external debt to GDP ratio and Rate of inflation is found to have a negative and
significant effect.

Impact Stock of external debt to GDP of on Real GDP

It is implied that Stock of external debt to GDP had a negative contribution to economic growth of
Ethiopia and the result is significant at 1% level of significance. The coefficient of EDGDP is
7.374097 indicating that a one unit increase in the stock of debt will result in -7.374097 percent
decline in real gross domestic product. This indicates the existence of debt overhang problem in
the country. This implies that government with a heavy debt burden is forced to increase taxes in
the future in order to service high debt burden. Then, after-tax return on capital will be reduced
due to the rise in tax. As a result, the incentive to invest will be lowered. Thus, the decline in
investment results in slow economic growth (Krugman, 1987). This result is consistent with the
findings of Melese (2004) for Ethiopia, Wessene Kassa(2014) for Ethiopia , Muluget
Fekadu(2014), Kangara (2015) for Kenya and Elbadawi, et al(1996) for Sub Saharan countries.

Impact of the debt service as a ratio of export earning to RGDP

The debt service as a ratio of export earning had a positive contribution to economic growth of
Ethiopia and the result is significant at 10% level of significance. The coefficient of DSR is
2.141406 indicating that a one unit increase in the debt service will result in 2.141406 percent
increase in real gross domestic product. This result indicates the absence of debt overhang in the
long run period in the economy.

Impact of Real gross capital formation on Real GDP

The variable real investment (INV) which is used as a proxy variable to measure capital in the
economy had significantly positively affect RGDP in the long run. This shows that capital
influences output as it is included as an input in production and plays a major role in enhancing

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age The impact of external debt on Ethiopian economic growth (2001-2021)
growth which is consistent with the standard growth theory. The coefficient of INV is 0.0000909
indicating one percent increase in real investment as share of GDP induces 0.0000909 percent
increment in output and the result is significant at 5%. This result agrees with the result of studies
by Wessene Kassa(2014) for case of Ethiopia ,and Were (2001) for the case of Kenya.

The impact of Rate of inflation on Real GDP

Rate of inflation had a negative contribution to economic growth of Ethiopia and the result is
significant at 1% level of significance. The coefficient of INFL is -15.63014 indicating that a one
unit increase in rate of inflation will result in -15.63014 percent decline in real gross domestic
product. This result is consistent with the findings of Kristine et al. (2011). The reason is inflation
reduces investment because people could expend their money to survive than invest, which in turn
narrow the gap of saving-investment. Therefore, inflation will have negative effect on RGDP in
the future.

The impact of Active Labor force

The other variable is Active Labor force as share of total population has positive and significant
effect on economic growth of the country. The coefficient is 1.80695 which shows one unit in
labor force results in 1.80695 percent increase in output and significance in 1%. This is due to the
fact that labor is one factor of production whose increases enhances economic growth.

Short run result

The long run and short run coefficients of the model are found to be similarly related in except for
Stock of external debt to GDP ratio which is positively related in long run and the opposite in short
run.

The coefficient of real gross capital formation is -0.0004643 indicating one percent increase in real
investment as share of GDP and the result is significant at 5% level of significance. The coefficient
of EDGDP is -8.920132 indicating that a one unit increase in the stock of debt will result in
8.920132 percent decline in real gross domestic product and at 1% level of significance. The other
important variable is Active Labor force has the coefficient of -1.559369 which shows one unit in
labor force results in -1.559369 percent decrease in output and affect insignificantly. The other rest
of are insignificant as shown in the above table.

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age The impact of external debt on Ethiopian economic growth (2001-2021)
 CHAPTER 5

5. CONCLUSION AND POLICY RECOMMENDATION

5.1. CONCLUSION
A developing economy needs to tap all possible resources to mobilize required financial resources
for the implementation of its developmental programs. External debt is one of the essential tools
which supplement the internal financial resources particularly in developing economies where the
existence of severe shortage of capital is a common observance. However, the heavy reliance on
external debt for resource gap results in debt burden problem that is reflected in the form of rising
level of external debt stock and debt servicing. Therefore, wise and proper utilization of foreign
debt by investing in selective and productive investment and increasing the domestic saving are
the main concern.

The central focus of this study is examining the short run and long run impact of external debt on
economic growth in Ethiopia for the period 2001 to 2021. The study used Harrod- domar models
as a foundation for the empirical study. The OLS was used for the empirical analysis of short run
and long run relationship of external debt and economic growth. ADF test was used to check for
stationarity in the data, and all variables became stationary after first difference except Active
Labor force, real gross capital formation and real gross domestic product. The diagnostic tests
including multicollinearity, autocorrelation, hetroskedasticity, model specification, normality and
co-integration tests were applied and data passed all these tests.

The empirical analysis attempted to investigate the long run and short run relationship of external
debt and economic growth used growth equation which was originally borrowed from Elbawi
(1996).The equation was real gross domestic product as a function of real domestic investment,
total labor force as share of total population, total external debt as percentage of GDP, debt service
as percentage of export, inflation rate and real exchange rate. Both long run and short run empirical
results were consistent and revealed that both real investment and labor force as share of total
population have a positive significant relationship with economic growth which is in line with
conventional economic theories. On other hand, external debt stock as percentage of GDP was
found to have a negative significant relationship with economic growth. This implies high external
debt lower economic growth and evidences the existence of debt overhang problem in Ethiopia.

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age The impact of external debt on Ethiopian economic growth (2001-2021)
The other debt burden indicator variable debt service export ratio has shown a significant positive
relationship with economic growth. However, this relationship is unexpected since theoretically
debt services erodes and diverts resources that could be used for investment and growth to debt
repayments and thereby lowers foreign reserve of the country. In case of Ethiopia this was not
evidenced owing to the existence of huge debt relief, debt rescheduling and forgiveness that
prevents the appearance of crowd out effect. The other variable is inflation. This variable has
negatively significant nexus with economic growth in long run.

5.2. POLICY RECOMMENDATION

Based on the results found, the following policy recommendations are to be forwarded.

✓ External debt ought to be utilized properly and wisely by being invested on prioritized and
most productive investment such as basic infrastructure that also facilitate the productivity
of other sector of the economy.

✓ The borrowed fund should be channeled to the productive real sectors of the economy
rather than social consumption. Furthermore, the duration of debt profile should match the
nature of investment it is needed to finance so as to obviate debt maturity before earnings
from investments financed with it

✓ The government should focus on investment activities since it found to have positive effect
on economy. They should also play important roles in stimulating the economy and
encourage domestic saving. Thus, in long run foreign savings will only supplement rather
than replacing domestic savings.

✓ The country should introduce effective debt management as a major policy concern in order
to obviate the misutilization and mismanagement of debt. This will also avoid wastages
and mismatches in debt utilization.

✓ Another implication of this analysis is that policies that encourage domestic investments,
foreign direct investment and increased trade earnings and thereby effect GDP growth and
reduce dependence on external debt for development should be enforced.

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age The impact of external debt on Ethiopian economic growth (2001-2021)
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International Monetary Fund, April, Washington, DC.

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Krugman, P. (2010). Reinhart and Rogoff are confusing me, New York Times, 11 August.
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in Nigeria,‖ The macro theme Review 4(8), special issue iv, Multidisciplinary journal of global
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Pesaran, M. H. (2001). Bounds testing approaches to the analysis of level relationships .Bounds
testing approaches to the analysis of level relationships. . Journal of Applied Econometrics, 2001,
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Pesaran M.Hashem, and Shin Yongcheol. 1999. “An autoregressive modelling approach to
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Appendix
Annex 1: Correlation matrix
RGDPsq EDGDP DSR GrossC~l labour~r inflat~t exrate

RGDPsq 1.0000
EDGDP -0.4087 1.0000
DSR -0.4784 0.0102 1.0000
GrossCapital -0.4240 -0.2764 0.8575 1.0000
labourforc~r 0.7090 -0.2674 -0.8663 -0.7221 1.0000
inflations~t 0.0698 -0.5401 0.0091 0.2493 0.0624 1.0000
exrate -0.3962 -0.3103 0.7734 0.9785 -0.6976 0.3029 1.0000

Source: own computation using STATA14 Annex

2: Descriptive Statistics
. summarize RGDPsq EDGDP DSR GrossCapital labourforcewinsor inflationsqrt
Variable Obs Mean Std. Dev. Min Max

RGDPsq 21 96.04555 57.41999 1.3456 219.9289

EDGDP 21 35.73571 21.8989 10.51625 84.43963
DSR 21 12.35528 8.445988 2.793224 28.53743
GrossCapital 21 351361.4 380913.6 18468.05 1216585
labourforc~r 21 85.56754 .4335065 84.88136 86.15301

inflations~t
21 3.560193 1.326016 .8216381 6.660082
Source: own computation using STATA14 Annex

3: Unit root test

Null Hypothesis: RGDP has a unit root

Exogenous: Constant
Lag Length: 0 (Automatic - based on SIC, maxlag=2)

t-Statistic
Prob.*

-2.612565
Augmented Dickey -Fuller test statistic 0.1070
Test critical values: 1% level -3.808546
5% level -3.020686

10% level -2.650413

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age The impact of external debt on Ethiopian economic growth (2001-2021)
Null Hypothesis: RGDP_SQ has a unit root
Exogenous: Constant, Linear Trend
Lag Length: 0 (Automatic - based on SIC, maxlag=2)

t-Statistic
Prob.*

Augmented Di ckey-Fuller test statistic -2.766952

0.2237 Test critical values: 1% level -4.498307

5% level -3.658446

10% level -3.268973

Null Hypothesis: EDGDP has a unit root

Exogenous: Constant
Lag Length: 2 (Automatic - based on SIC, maxlag=2)

t-Statistic
Prob.*

-6.471501
Augmented Dickey -Fuller test statistic 0.0001
Test critical values: 1% level -3.857386
5% level -3.040391

10% level -2.660551

Null Hypothesis: EDGDP has a unit root

Exogenous: Constant, Linear Trend
Lag Length: 2 (Automatic - based on SIC, maxlag=2)

t-Statistic
Prob.*

-5.634289
Augmented Dickey -Fuller test statistic 0.0014
Test critical values: 1% level -4.571559
5% level -3.690814

10% level -3.286909

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age The impact of external debt on Ethiopian economic growth (2001-2021)
Null Hypothesis: DSR has a unit root
Exogenous: Constant
Lag Length: 0 (Automatic - based on SIC, maxlag=2)

t-Statistic
Prob.*

-0.846366
Augmented Dickey -Fuller test statistic 0.7835
Test critical values: 1% level -3.808546
5% level -3.020686

10% level -2.650413

Null Hypothesis: DSR has a unit root

Exogenous: Constant, Linear Trend
Lag Length: 0 (Automatic - based on SIC, maxlag=2)

t-Statistic
Prob.*

-3.764037
Augmented Dickey -Fuller test statistic 0.0411
Test critical values: 1% level -4.498307
5% level -3.658446
10% level -3.268973

Null Hypothesis: GROSS_CAPITAL has a unit root

Exogenous: Constant
Lag Length: 1 (Automatic - based on SIC, maxlag=2)

t-Statistic
Prob.*

5.491701
Augmented Dickey -Fuller test statistic 1.0000
Test critical values: 1% level -3.831511

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age The impact of external debt on Ethiopian economic growth (2001-2021)
 5% level -3.029970

10% level -2.655194

Null Hypothesis: GROSS_CAPITAL has a unit root

Exogenous: Constant, Linear Trend
Lag Length: 1 (Automatic - based on SIC, maxlag=2)

t-Statistic
Prob.*

1.138665
Augmented Dickey -Fuller test statistic 0.9998
Test critical values: 1% level -4.532598
5% level -3.673616
10% level -3.277364

Null Hypothesis: INFLATION_SQRT has a unit root

Exogenous: Constant
Lag Length: 0 (Automatic - based on SIC, maxlag=2)

t-Statistic
Prob.*

-3.348221
Augmented Dickey -Fuller test statistic 0.0261
Test critical values: 1% level -3.808546
5% level -3.020686

10% level -2.650413

Null Hypothesis: INFLATION_SQRT has a unit root

Exogenous: Constant, Linear Trend
Lag Length: 0 (Automatic - based on SIC, maxlag=2)

t-Statistic
Prob.*

-3.555507
Augmented Dickey -Fuller test statistic 0.0603
Test critical values: 1% level -4.498307

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 5% level -3.658446
10% level -3.268973

Null Hypothesis: LABOUR_FORCE_WINSOR has a unit root

Exogenous: Constant
Lag Length: 1 (Automatic - based on SIC, maxlag=2)

t-Statistic Prob.*

Augmented Dickey -Fuller test statistic -1.685980 0.4219

Test critical values: 1% level -3.831511
5% level -3.029970
10% level -2.655194

Null Hypothesis: LABOUR_FORCE_WINSOR has a unit root

Exogenous: Constant, Linear Trend
Lag Length: 0 (Automatic - based on SIC, maxlag=2)

t-Statistic Prob.*

Augmented Dickey -Fuller test statistic 0.0001

Test critical values: 1% level -4.498307
5% level -3.658446
10% level -3.268973

Source: own computation by Eviews10

. matrix list e(lags)

e(lags)[1,6]
RGDPsq EDGDP DSR GrossCapital labourforc~r inflations~t r1

1 2 2 2 2 0 Source: own
computation using STATA14

Annex 4: Result of Bound Test for Co-Integration

Pesaran/Shin/Smith (2001) ARDL Bounds Test

H0: no levels relationship F = 6.108
t = -5.612 Critical Values (0.1-0.01), F-statistic,
Case 3
[I_0] [I_1] [I_0] [I_1] [I_0] [I_1] [I_0] [I_1]
L_1 L_1 L_05 L_05 L_025 L_025 L_01 L_01

k_5

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age The impact of external debt on Ethiopian economic growth (2001-2021)
 2.26 3.35 2.62 3.79 2.96 4.18 3.41 4.68
accept if F < critical value for I(0) regressors reject
if F > critical value for I(1) regressors Critical
Values (0.1-0.01), t-statistic, Case 3
[I_0] [I_1] [I_0] [I_1] [I_0] [I_1] [I_0] [I_1]
L_1 L_1 L_05 L_05 L_025 L_025 L_01 L_01

k_5
-2.57 -3.86 -2.86 -4.19 -3.13 -4.46 -3.43 -4.79
accept if t > critical value for I(0) regressors reject
if t < critical value for I(1) regressors

k: # of non-deterministic regressors in long-run relationship Critical

values from Pesaran/Shin/Smith (2001)

.
Source: own computation using STATA14

Annex 5: Diagnostic Tests

1. heteroskedasticity
. estat hettest

Breusch-Pagan / Cook-Weisberg test for heteroskedasticity

Ho: Constant variance
Variables: fitted values of RGDPsq

chi2(1) = 0.74
Prob > chi2 = 0.3894

Source: own computation using STATA14

2. Model specification test
. estat ovtest

Ramsey RESET test using powers of the fitted values of RGDPsq

Ho: model has no omitted variables
F(3, 12) = 0.96
Prob > F = 0.4428

Source: own computation using STATA14

3. Multicollinearity test
. estat vif
Variable VIF 1/VIF

DSR 7.77 0.128675

GrossCapital 6.20 0.161388
labourforc~r 6.08 0.164400
EDGDP 2.51 0.398115

45 | P
age The impact of external debt on Ethiopian economic growth (2001-2021)
inflations~t 1.53 0.654690

Mean VIF 4.82

Source: own computation using STATA14

4. Auto-correlation test
. estat bgodfrey, lags(2)

Breusch-Godfrey LM test for autocorrelation

lags(p) chi2 df Prob > chi2

2 1.864 2 0.3938

H0: no serial correlation

. estat dwatson

Durbin-Watson d-statistic( 6, 21) = 2.190106

5 Normality test

Skewness/Kurtosis tests for Normality

joint
Variable Obs Pr(Skewness) Pr(Kurtosis) adj chi2(2) Prob>chi2

RGDPsq 21 0.4613 0.9913 0.57 0.7525

EDGDP 21 0.0175 0.4009 5.92 0.0518
DSR 21 0.2607 0.0522 4.98 0.0828
GrossCapital 21 0.0475 0.9836 4.16 0.1249
labourforc~r 21 0.6983 0.0827 3.57 0.1681
inflations~t 21 0.3514 0.3463 1.95 0.3767
Source: own computation using STATA14

46 | P
age The impact of external debt on Ethiopian economic growth (2001-2021)