Abstract:

This study examines the sustainability and relationship of public debt to selected macroeconomic variables for South Asian Association of Regional Cooperation (SAARC) countries from 1996 to 2017. For the relationship of public debt to macroeconomic variables, we employ a panel Autoregressive Distributed Lagged (ARDL) model. For sustainability measurement of public debt, we used a theoretically derived model based on necessary and sufficient conditions. The panel ARDL results for the long run show that the saving-investment gap and economic growth negatively while the budget deficit and current account positively explain public debt. The sustainability measurement results based on necessary and sufficient conditions reveal that public debt remains unsustainable for most of the years in the presence of macroeconomic variables. It is recommended that countries in this association should formulate policies that promote saving culture. This saving culture may not only promote investment but also can affect the current account situation of these countries.

Key Words:

Public Debt, Macroeconomic Variables, Panel ARDL, Sustainability, SAARC Countries

Introduction

A country on the verge of its development stage is trying to bring economic stability and needs to focus on sectors that boost economic growth, e.g., production, consumption, and investment. Since the government does invest in some sectors due to its moral responsibilities like spending on health, education, water, and sanitation, social safety, communications (roads and highways), etc., these are the areas where private investors hesitate to invest. So, if the government wants to encourage the private sector to boost their investment and enhance their confidence, then they can go for some huge amount of initial injection into the economy. Debt importance and harmfulness analysis are one of the core areas of research for both developed and developing nations of the world. Both developed and developing countries incurred debt, but the situation becomes more suppressing when it is observed and imperialized that the debt which is initiated for the growth, stability, and economic development destabilized the growth and development. The entire world, in the course of time does acquire debt whether it is a developed or developing nation (Reinhart & Rogoff, 2008). (Benayed, Gabsi, & Belguith, 2015) were of the view that policymakers and economists from the world got attention toward rising public debt and its negative impacts on the economy. (Campos, Jaimovich, & Panizza, 2006) Attributed the accumulation of public debt to the budget deficit in the economy. They further say that change in the stock of debt is equal to the budget deficit.

Debt sustainability at one end represents the economic growth that it brings to sustained the economy in the future, and at another end, it represents the number of surpluses it produces to repay the debt obligations without rescheduling the debt payments. A sustainable debt is one that produces surpluses, which are sufficient to repay the debt obligation in the future. The public debt sustainability issue got attention after the 1980’s era. Several methods were introduced by researchers to find out the sustainability of public debt. The studies are based on using fiscal account measures for the public debt sustainability through a unit root and cointegration testing approaches see (Greiner & Semmler, 1999; Hakkio & Rush, 1991; Hamilton & Flavin, 1985; Wilcox, 1989). Other sets of studies focused on the current account situation and debt sustainability using unit root and cointegration testing procedures see (CArneiro, 1997; Rocha & Bender, 2000; Sawada, 1994).

The current study is focusing on the South Asian Association for Regional Cooperation (SAARC) countries. SAARC countries represent 21 percent of the world population and about 4.23 percent of the global economy up to 2019. Based on the area, SAARC comprises about 3 percent of the world area. SAARC aims to promote the quality of life and welfare of the associated nation’s peoples, to realize the associated countries full potential for the enhancing economic growth process, social and cultural development progress plus active collaboration and mutual assistance in the fields of social, cultural, economic, technical and scientific for transfer of knowledge and skills, to address and depend one another on international forums on the matters of common interest, to enhance mutual trade among the associated countries and to work together with other organization either regional or non-regional with similar purpose and objectives. 

However, literature about the saving investment gap is least evident about the relationship and deciding the sustainability of public debt, especially in SAARC countries. The objective of the current study is to imperialized the relationship and sustainability of public debt in the presence of saving investment gap, fiscal outcome ( budget deficit or surplus), current account (surplus or deficit), and GDP growth rate.

Literature Review

Forslund, Lima, and Panizza (2011) used a data set of 95 countries designated as developing countries emerging markets to assess the determinants of public debt; results of the study show that domestic debt size and inflation at the national level were weakly associated if the current account is kept control. However, countries with a more liberalized or neutral capital flow, inflation, and public debt relationship is mostly contradictory. Teles and Mussolini (2014) show that economic growth insignificantly affects the debt. Further, they found a significant relationship between debt taken for productive expenditure and economic growth; their results also suggest that economic growth for an economy can be stimulated by an increase in productive public debt for expenditures. Do?an and Bilgili (2014) estimate the impact of public and private external debt on economic growth. The finding of the study suggests that debt affect economic growth negatively. Further, the study also shows that negative affect on economic growth mainly comes from the public external debt. Qayyum, Din, and Haider (2014) developed a theoretical model for external debt, foreign aid, and governance in an open economy. The study showed that foreign aid and external debt have a level impact on consumption instead of growth rate effect. Investment is not affected by foreign aid directly, but saving is directly and positively affected by foreign aid. Economic growth is positively affected by foreign aid, and it plays a constructive role in increasing economic activities. On the other hand, external debt negatively affected growth and imposed a burden on the economy by pushing it into a debt trap and further troubles. The study recommended that developing countries should use foreign aid for financing budgets instead of going into debt. Van Bon (2015) studied 60 developing countries in Africa, Asia, and Latin America for determining the debt situation. The findings of the study show that trade openness, government expenditures, private investment, and real GDP per capita significantly determined the public debt. Sustainability of debt achievement is important for a country because an unsustainable debt leads to an increase in indebtedness. Macroeconomic literature and textbooks agreed upon that to finance the development process poor countries need to borrow.  When indebtedness become large in poor countries the rate of investment also reduce in it, mean the profit on investment in the poor countries expected to be taxed away and process of growth and development may become stagnant see (Krugman, 1988; Sachs, 1988). Empirical studies also use the cointegration method for testing debt sustainability. The focus is made on the long-run relationship between revenues and expenditures. Debt is accounted as sustainable when a long run relationship exists. Several country base and region base studies were conducted to determine the sustainability of debt. Country-based studies on the sustainability of public debt include (Crowder, 1997; Haug, 1991; Quintos, 1995; Tanner & Liu, 1994). For region-wise research on debt sustainability base on co-integration relationship see (Afonso, 2005; Ahmed & Rogers, 1995; Papadopoulos & Sidiropoulos, 1999; Payne, 1997). Fincke and Greiner (2011) argued that a fiscal policy could satisfy the intertemporal budget constraint of the government when the primary surplus to public debt remains positive and significant.  A sustainable fiscal policy for debt is one that enables the government to have debt today and primary surpluses in the future. According to Schumacher and di Mauro (2015), it is important to analyze the sustainability of debt for an economy because it helps in determining the future position of debt accumulation. Sustainability enables us to find that the debt accumulation in near future will remain stable or explosive.

Theoretical Framework The Individual’s Consumption’s Problem

To build up the theoretical aspect of the study, a small hypothetical open developing economy consisting of four sectors (i.e. households, business, government, and foreign) is considered. The Formulization of this economy is based on the two-periods microeconomic model of saving, which consumes a single good (Irving, 1930). In the current study, consumption involves two goods; time is modified to many time periods. The individuals are N numbers in the economy. Every individual in the economy possessed an initial endowment. The N number of individuals try to maximize their lifetime utility U_N, which depends on different level of consumptions C_i consumed in the life time. The life time utility of the individuals  can be expressed as:

U_(N,j)= ?_(j=1)^???_j^t   U(C_(N,j) )………………(1)

where U is utility, j represents the number of goods consumed. The utility depends on consumption bundle individual consumed U(C_(N,j) ) which is in additive form and the time discounted factor ?_j^t Which measure the impatience of individuals regarding his decision about current and future consumption opportunities. The utility is assumed to be time separable means that we can compare the one-time utility of an individual to its other time utility. Representative individual choices, consumption, saving, etc., represent the overall N number of individuals, and utility is derived from the N individual’s joint utility function with some assumptions and modifications.  Individuals consumed two goods, necessities and luxuries, and analyses are carried out for the current time. Daily life goods which are available in the economy are referred necessities and available in two forms, i.e. home country products and imported from a foreign country. Luxury goods are also available in a homemade form and foreign-made imported form. The utility can be derived from (1) as:

U_(R,i)=??u(C_(R,i) ) ……..…………………....(2)

where U_R Is the utility of representative individual, C is consumption bundle, i mean necessities and luxuries. Further, that utility function u(C_(R,i) ) is increasing in consumption and strictly concave: u^' (C_(R,i)) >0 and u^'' (C_(R,i)) <0.

The income channel can be described as, referring to the aggregate production function possibilities set, which is a set that represents a vector of all feasible net output for the whole economy as Y=?_(j=1)^K?Y_j  The mean sum of all individual possibility production sets makes the Production function. The representative inhabitant can either be a consumer or seller; both are shown by net output. If Y is given as y=?_(j=1)^K?y_j = y_R So it means that an individual firm production plan y is included. So, a profit-maximizing firm will choose the following profit function.

?_j=?_(j=1)^K??py?_j = ?_R……………………(3)

where the vector of output prices represented by p and ?_j show the income of every individual and is also the income of a representative individual?_R. Now Lagrange optimizing function can be set for obtaining the optimal solution sets of both necessities and luxuries as;

L=u (C_(R,NE,LU) )- F (pC_(R,NE,LU)-?_R )…(4)

The optimal solution generates the following aggregate demand function.

C(p)= ?_(q=1)^Z?C_(R,NE,LU)  (p_(NE,LU) ) ?_R…………(5)

Aggregating Individuals and Completing the Model

If all individuals are identical in the economy with the size equal to N and dropping the subscript can give us the quantities of variables in national aggregate quantities. Let aggregate consumption and aggregate output are represented by C and Y respectively with the assumption of an identical population of size N implies that ?C_t=C?_(R,NE,LU) and ?_R=Y_t. For all N inhabitant in the economy at time t. This national inhabitant tries to follow a flat aggregate consumption over time. Further, the representative inhabitant use for aggregate behavior can be justified from (Deaton & Muellbauer, 1980).

Current Account (CA)

Since the assumed economy is open, the consumption is no longer tied up to its domestic output only. The current account situation of the economy can be expressed as;

?CA?_t=Y_t-C_(T,t)……………………….………(6)

where ?CA?_t is a current account at time t, Y_t is GDP and C_(T,t) is total consumption. Further C_(T,t) is defined as C_(T,t)= C_(D,t)+C_(I,t) where C_(D,t) is domestic consumption and C_(I,t) is the consumption of imported.

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