THE IMPACT OF GOVERNMENT DEBT ON THE ECONOMIC GROWTH OF BHUTAN

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1 THE IMPACT OF GOVERNMENT DEBT ON THE ECONOMIC GROWTH OF BHUTAN SONAM WANGMO Graduae School of Developmen Economics, NIDA, Thailand Absrac - The sudy aims o empirically examine he relaionship beween he governmen deb and economic growh in Bhuan. The sudy was moivaed by he unprecedened increase in he level of governmen deb currenly prevailing in Bhuan. To deermine he relaionship he daa were obained from World Economic Oulook (IMF), World Bank and Naional saisics Bureau of Bhuan. Time series daa from he period 1990 o 2016 were fied ino he regression equaion using various economic echniques. The resul of Augmened Dicky Fuller (ADF) and Phillips Perron (PP) uni roo es sugges ha all he variables are non-saionary a level bu exhibi saionary afer he firs difference. The Johansen co-inegraion es and Vecor Error Correcion Model (VECM) is employed o invesigae he effec of deb on real gross domesic produc growh. Index Terms - Governmen Deb, Economic Growh, Co-Inegraion Tes, Vecor Error Correcion Model. I. INTRODUCTION Every naion seek o achieve susained economic growh. However, achieving his objecive of economic growh is a major concern especially for he Leas Developed Counries (LDCs). Owing o low level of invesmen and savings, he LDCs faces low capial formaion [1]. Moreover, many facor pose problem and proves o be derimenal o he economic growh. One of such facor is he governmen deb. Deb is a universal and an acknowledged phenomena faced by all counries irrespecive of he economy being small or large. Deb is he oal amoun of money ha he governmen of a counry owes. Given a limied resources and insufficien funds, a counry sruggles in financing is developmenal projecs and achieving is naional objecives. The means by which he governmen can generae revenue are by increasing axes and prining more money. However, he revenue, which he governmen raises in he form of ax alone is no enough o suppor he developmenal projecs and on he oher hand prining more money is no a wise decision for he governmen because i will dissuade he sabiliy of he economy. So for his paricular reason a counry choose o borrow from boh inernal and exernal sources o increase he welfare of he people and o finance he developmen of he infrasrucures ha are necessary o achieve economic growh [2]. Deb is no only a problem a he micro economic level bu i is also a serious issue a macro-economic level. Almos all he counries in he world encouners he effec of deb bu he level o which a counry faces his effec differs from counry o counry. According o he saisics poral, in 2016 he deb of he Unied Saes reached % in relaion o he Gross Domesic Produc (GDP). The counry wih he highes public deb in relaion o GDP is Japan which recorded a deb of % in In general, he relaionship amongs he governmen deb and economic developmen is essenial for he policy makers and he public and here are some pas sudies which examines his relaionship. Since here is no clear cu answer on he impac of governmen deb on he economic developmen of a counry, he relaionship beween governmen deb and economic growh is much debaable. Pas sudies and researchers view public deb boh as a burden o he sociey and derimenal o invesmen and growh as well as beneficial o he economic growh. Differen sudies in he pas has found ha incurring deb poses eiher a posiive [3] or a negaive [4] impac on he GDP of a counry. The impac of governmen deb depends on how i is being uilized. If he governmen spends on invesmen oriened projecs such as agriculure, elecriciy generaion and infrasrucures i will have a posiive growh. On he oher hand if he deb is used for privae and public consumpion hen he effec on he economy will be negaive. For any governmen he main reason for borrowing mus be for he developmen of he counry raher on consumpion. When he borrowed funds are uilized opimally, he deb need no necessarily ransform ino a deb burden. Over he pas years Bhuan have been facing a mixed economic performance. Bhuan being a small and an underdeveloped counry, i has very limied resources. The financial insiuions and capial markes are no fully developed resuling in he shorage of invesable funds. Therefore, he counry has been depending on he deb and foreign grans o finance he projecs such as elecriciy generaion plans, consrucion of roads, educaion, healh, agriculure, ec. In Bhuan he deb-gdp raio was recorded he lowes a 36.90% in 1998 however he siuaion changed as deb sared o grow from According o he Naional budge [5], Proceedings of 175 h The IIER Inernaional Conference, Bangkok, Thailand, 21 s -22 nd July,

2 he highes oal public deb recorded by Bhuan was 113% of he GDP in This increase in governmen deb has become a naional concern. The differen poliical poins of view relaed o he deb burden have raised an inense debae on he poenial adverse consequences due o increase of public borrowing on he economic growh of Bhuan. Aribuing o coninuous increase in he level of deb and in an effor o guide he invesmen and o guaranee ha public deb is kep a a susainable level, he governmen has come up wih a comprehensive public deb policy. The main objecive of he sudy is o examine he possible relaionship beween he governmen deb and economic growh in Bhuan. The oucome of his research will guide he policy makers o make appropriae decisions on wheher he governmen should coninue o rely on debs or resor o addiional ax or some oher desirable measures. This sudy is divided ino five chapers. Chaper I is he inroducion par. Chaper II is he Lieraure review which includes he heoreical framework and he empirical review. Chaper III presens he mehodology used in he sudy. Chaper IV discusses he empirical resuls and finally chaper V presens he conclusion. II. LITERATURE REVIEW A. Theoreical framework The main aim of he research is o find he possible impac of governmen borrowing on he economic growh. As per Sala-i-marin, various economic heories on growh fail o recognize he main facors ha affec he economic growh. So as measure a cross secional regression has been recommended. The regression model is as follows: GRDPG X X The Impac of Governmen Deb on he Economic Growh of Bhuan 2 20 n X n Where GRGDP is he economic growh rae and X 10.. X n are he possible independen variables ha may differ from one sudy o anoher. The researchers usually include hose explanaory variables which bes deermine he economic growh of ha paricular economy. For example, [6] employed governmen deb, he GDP per capia, savings, expors, impors, shor erm nominal ineres rae, populaion, unemploymen, rade and growh rae of populaion as some of he variables ha deermined he rae of economic growh (GDP). Many researchers proposed a heory called a dual gap heory, which explains abou he issue of exernal deb. The heory jusifies he purpose why counries resor o exernal finance o ensure susained Proceedings of 175 h The IIER Inernaional Conference, Bangkok, Thailand, 21 s -22 nd July, economic growh. The heory suggess ha economic developmen akes place wih he increase in invesmen level. Invesmen is a funcion of saving and in some counries, he domesic savings is no sufficien o confirm he developmen of he economy. Therefore, counries find i logical o obain exernal funds o finance he developmenal aciviies. The dual gap analysis saes ha o achieve economic growh a counry needs saving and invesmen and impored goods. However, o accomplish he goal of economic developmen, domesic savings may no be enough, which will resul in a gap beween savings and invesmen. B. Empirical Review Recenly, he discussion on deb has capured a lo of aenion from he public and policymakers because of he impac i caused on he growh of an economy. A series of researches have been carried ou o discover he impac of governmen indebedness on he growh of he economy and also o find ou he relaionship beween hese variables. However, he findings of hose sudies were eiher conflicing, unclear or differed from each oher depending on he counries being examined, he ime period, he mehod and he variables included in he model. Empirical sudies found boh posiive and adverse impac of governmen deb on deermining he economic performance of a counry and some sudies found he causaliy connecion amongs deb and economic growh. Deb have been recognized boh as a blessing and a curse on he economic growh. In a sudy of 80 developing counries, [7] found ha he counries wih good policies and insiuions faced negaive impac from deb when i crossed 15 o 30 percen of GDP. Bu, however once i exceed 70 o 80 percen, he marginal effec becomes irrelevan. As compared o he counries wih bad policies and insiuions, hese hreshold levels are higher. Reference [8] using simple ordinary leas square mehod found ha in Ghana deb is negaively associaed wih growh because of he presence of corrupion and inefficien managemen of he deb. They suggesed ha revenue should be increased hrough ax reform programs insead of borrowing. Using srucural hreshold regression o examine he impac of deb on growh, [9] concluded ha in counries wih low-democracy regime, high public deb lead o lower growh when compared o counries wih high-democracy regime. Reference [10] analyzed he effec of public deb on he economic performance for EMU (European Economic and Moneary Union) counries. They found ha in he long run deb had a negaive effec on he oupu depending on he final allocaion of he deb i.e. on producive or unproducive expendiure. Reference [11] invesigaed he relaionship beween deb and growh for a number

3 of developing and indusrial economies over he period 1970 o The empirical resul provides ha for developing counries he lower exernal debs are associaed wih high growh raes which is driven by he incidence of public exernal deb and no by privae exernal deb. And on he oher hand here was no significan relaionship beween deb and growh for he indusrial economies. Reference [12] sudied he relaionship beween public deb and economic growh. The analysis is based on he panel daa covering seven developed counries over he period 1970 o In heir sudy, hey esimae a random effecs model and pooled regression model and heir resuls reveal ha here exiss a negaive relaionship beween deb and economic growh. Reference [13] confirmed a posiive relaionship beween domesic deb and economic growh in Pakisan over a period 1972 o The reason of his posiive relaionship is because he borrowed funds have been used o finance hose expendiures of governmen which conribues o he growh of economy. Empirical resul showed ha deb was he source which boosed he economic performance in Nepal [14]. Nepal is a mixed economy and a land locked economy wih high dependence on foreign aid and agriculure. Employing daa of 30 years, [15] found ha he governmen deb, gross domesic produc and gross naional saving are he imporan facors which conribued significanly o he growh in Euro Area counries. Reference [16] sudied he link beween exernal deb and economic growh for he period 1981 o Using ordinary leas square regression, he sudy concluded ha exernal deb and he gross domesic produc are posiively relaed. This finding is suppored he previous sudy done in Nigeria by [17]. The effec of governmen deb on he economic developmen depends on how he deb is being used. Reference [18] found he esimaed hreshold for governmen deb o be around 85%. The deb beyond he hreshold was derimenal o he economic growh whereas he moderae level boosed growh. A high level of public deb can adversely affec economic growh of capial socks and produciviy [19]. Reference [20] found ha a 60% deb level i had less impac on he economic growh whereas beyond 90% he economic performance slowed down. Reference [21] empirically invesigaed he impac of deb on he economic growh of Malaysia. The sudy used quarerly daa from he firs quarer of 2000 o he fourh quarer of The resuls from Vecor Error Correcion Model (VECM) and Vecor Auo Regression (VAR) Model found ha here is no significan impac of deb on he growh in boh shor run as well as in he long run. In a sudy on African exernal deb problem in comparison o Nigeria and Morocco, [22] concluded ha invesmen was severely hampered by exernal deb and ha fiscal expendiure, balance of paymen and global ineres raes mainly aribued o he The Impac of Governmen Deb on he Economic Growh of Bhuan Proceedings of 175 h The IIER Inernaional Conference, Bangkok, Thailand, 21 s -22 nd July, accumulaion of deb in hese wo counries. In an effor o remove he problem, he suggesed measures such as developmen of capial markes, expor promoion and privaizaion. In he sudy by [23], he found he presence of boh shor run and long run relaionship beween he governmen indebedness, expor and economic growh in Greece. The granger causaliy showed ha in he shor run here does no exis a causal relaionship beween deb and expors bu however a unidirecional Granger causaliy exised from economic growh o governmen deb in he long run. Reference [24] in his sudy of he relaionship beween exernal deb, expors and economic developmen in Lebanon found ha here exised a unidirecional Granger causaliy from deb o expors and hen from expors o GDP growh. Using he augmened VAR model approach in G7 counries [25] examined he causaliy direcion beween deb and economic growh and he sudy showed ha raher han deb causing growh i was he oher way round. III. METHODOLOGY A. The Model Specificaion Wih some modificaion we adop a simple macroeconomic model used by Ada (2016). The model is specified as given below: GDPG 0 1DEBT 2UNEMP 3 INFL The Vecor Error Correcion Model (VECM) is adoped o deermine he growh equaion in he shor run. The model is specified as given below: GDPG UNEMP 3 GDPG INFL DEBT 1 Where, Δ is he difference operaor ECT is he error correcion erm 2 ECT B. DATA DESCRIPTION To invesigae he impac of governmen deb on he GDP growh of Bhuan we use annual ime series from 1990 o Table I presens he definiions and he source of he variables being used for our sudy. Table I- Definiions and Sources of he Variables Variables Definiion Source GDPG DEBT Real GDP growh rae. I capures he change in he value of final goods and services produced in an economy for a paricular period of ime. World Economic Oulook (IMF)

4 UNEMP INFL Governmen deb as a percenage of GDP. I shows he effec of deb on he GDP growh. Rae of unemploymen (Annual %). Inflaion rae (Annual %) IV. EMPIRICAL RESULTS The Impac of Governmen Deb on he Economic Growh of Bhuan World Bank World Bank Naional Saisics Bureau, Bhuan The descripive saisics of he variables employed in he sudy are displayed in Table II. The sudy used annual daa from 1990 o 2016 covering a period of 27 years. The GDP growh (GDPG) is he dependen variable which is used as a proxy of economic growh. The explanaory variables includes governmen deb, unemploymen and inflaion. To undersand he srucure of he daa descripive saisics were calculaed. The descripive saisics shows how he daa behaved. Table II- Descripive saisics Variable GDPG DEBT UNEMP INFL Mean Sandard Deviaion Minimum Maximum Variance Skewness Kurosis Source summarized by Auhor Over he period under sudy, he economy of Bhuan grew by an average of 6.6 percen. The minimum growh was recorded 2.1 percen and he maximum growh was 12.9 percen. As shown by he sandard deviaion he growh varied a 2.5 percen. The counry s deb averaged percen reaching a maximum and minimum of and 27.1 percen respecively. The sandard deviaion was 22.2 percen indicaing ha he level of governmen deb varied over he years. The unemploymen rae averaged a 2.6 percen wihin a minimum and maximum of 1.3 and 4 percen respecively. The minimum and maximum level of inflaion recorded was 2.1 and 15.9 percen respecively wih a sandard deviaion of 3.3 percen. Skewness shows he disribuion of he variables around is mean. The series are normally disribued if he skewness level is zero. A posiive skewed variables shows a long righ ail and a negaive skewed indicaes a long lef ail. From he resul we can see ha GDPG, DEBT and INFL are posiively skewed while UNEMP Proceedings of 175 h The IIER Inernaional Conference, Bangkok, Thailand, 21 s -22 nd July, is negaively skewed. Kurosis measures he peakness and flaness of he disribuion of series. A series is normally disribued when he Kurosis value is 3. Kurosis value above hree implies ha he disribuion is peaked (lepokuric) and when he value is below hree he disribuion is playkuric (fla). As shown in he resul he variables are well disribued. The ime series daa were esed for is saionary. The saionary es is mandaory because mos of he ime series daa are non-saionary and running he es will help us o avoid spurious regression oucomes. For he sudy we employ Augmened Dicky Fuller and Phillips Perron uni roo es a boh level and a firs difference. The decision rule for he uni roo es is ha if he esimaed ADF and PP values are higher han he criical values (in absolue erms) we rejec he null hypohesis (he variable is non-saionary and here is a presence of uni roo) and herefore accep he alernaive hypohesis (no uni roo and saionary). However if he ADF and PP es saisics are less han he criical value we accep he null hypohesis. The saionary of daa is crucial for he Johansen co-inegraion es. To make he non-saionary series ino saionary, he series mus be modeled in firs difference. The resul from he uni roo es in Table III shows ha all variables which are non-saionary a level are made saionary a firs difference and herefore are inegraed of order I(1). Table III- ADF and PP uni roo ess Augmened Dicky- Fuller Phillip-Perron Variables Level Firs Firs Level Difference Difference GDPG * * DEBT * * UNEMP * * INFL * * ** implies he level of significance a 1% level Source- Auhors compuaion To esimae he Johansen co-inegraion and vecor error correcion model (VECM) i is imporan ha a lag lengh be seleced. The lag lengh is seleced based on he crierion such as Final predicion Error (FPE), Akaike s Informaion Crierion (AIC) and Hannan Quinn Informaion Crierion (HQIC) and Schwarz s Bayesian Informaion Crierion (SBIC). The mos suiable lag lengh was found o be 1 as presened in Table IV. Table IV- Opimal lag lengh selecion Lag lengh FPE AIC HQIC SBIC * * * * Source- Auhors compuaion

5 Since all he variables are co-inegraed a I(1) here is a probabiliy of co-inegraion among he variables. We perform co-inegraion es o find ou wheher here is a long run relaionship among he variables or no. In his sudy we use he Johansen co-inegraion approach. To find he number of co-inegraing vecors, he Johansen s mehodology uses race saisics. The decision rule for he co-inegraion es is ha if he race saisics value is higher han he criical values a 5% significance level we rejec he null hypohesis of no co-inegraion and accep he alernaive hypohesis of co-inegraion. Null hypohesis Table V- Johansen Co-inegraion es resul Trace saisics r = r r r Source- Auhors compuaion The Impac of Governmen Deb on he Economic Growh of Bhuan Criical value (5%) The resul from he Johansen co-inegraion es displayed in Table V consising of race saisics indicaes ha here is one co-inegraing equaion. For he null hypohesis H 0 :r=0, he resul indicaes ha he race saisics of is higher han he criical value of indicaing ha he null hypohesis of no co-inegraion agains he alernaive hypohesis is clearly rejeced. Therefore, he resul sugges ha here is a long run relaionship beween he variables under sudy meaning ha economic growh, deb, unemploymen and inflaion are co-inegraed indicaing ha hese variables move ogeher in he long run. The long run normalized growh equaion is shown in Table VI. Table VI- Long Run Normalized co-inegraion equaion Dependen variable (GDPG) Explanaory Variables Coefficien -sa Prob. DEBT ** UNEMP * INFL * _cons *, ** and *** denoes 1%, 5% and 10% significance level respecively. Source- Auhors compuaion governmen deb and inflaion are negaively associaed wih he growh rae of GDP and are saisically significan a 5% and 1% respecively. The negaive coefficien of DEBT indicaes ha deb hampers he economic developmen of Bhuan. This negaive relaionship is suppored by he sudy carried ou by [26]. He invesigaed he relaionship amongs exernal deb and economic growh in Nigeria employing auoregressive disribued lag (ARDL) approach. The findings showed ha in he long run deb and economic growh are inversely relaed. Deb migh be used inappropriaely which will deer he growh of he enire counry. The coefficiens of INFL is also negaive indicaing ha inflaion has an inverse relaionship wih he growh of GDP in he long run. This empirical finding is suppored by [27]. On he oher hand he coefficien of unemploymen is posiive and saisically significan a 1% significance level. I implies ha in he long run unemploymen and economic growh are posiively relaed. The reason for his posiive relaionship is due o he fac ha Bhuanese economy is driven by he elecriciy generaion which requires more of advanced echnology (Capial inensive mehod) and less of human resource. This finding is suppored by [28]. The oucome of he resul indicaes ha all growh equaion deerminans suppors he hypohesized signs excep for unemploymen. The shor run co-inegraion equaion resul is presened in Table VII. The error correcion erm (ECT) or he coefficien shows he speed of adjusmen caused by any disequilibrium owards he long run equilibrium. Table VII- shor Run co-inegraion resul (Adjusmen Parameers) Coefficien Sandard error -sas Prob. GDPG * DEBT 1.102*** UNEMP 0.154* INFL *** * and *** denoes significance a 1% and 10% respecively. Source- Auhors compuaion From he resul we can specify he shor run equaion as given below: GDPG 1.102DEBT 0.154UNEMP 0.287INFL. From he resul we express he long run equaion as follows: GDPG DEBT UNEMP INFL From he above resul we can conclude ha We can beer undersand he movemen of he variables in he shor run by looking a he coefficiens of each variables. The coefficiens of GDPG, DEBT, UNEMP and INFL are , 1.102, and respecively. From he resul i indicaes ha he speed of adjusmen of GDPG, DEBT, UNEMP and INFL from shor run disequilibrium o long run equilibrium are 4.7%, 11%, 1.5% and 2.8% Proceedings of 175 h The IIER Inernaional Conference, Bangkok, Thailand, 21 s -22 nd July,

6 respecively. This signifies ha when he GDPG is high i moves owards DEBT by 4.7%. Similarly, given any disequilibrium in he previous year DEBT adjus iself owards GDPG by 11%. CONCLUSION The objecive of he sudy is o examine he possible relaionship beween he governmen deb and he economic growh of Bhuan. For he sudy he growh rae of GDP was used as a measure of economic growh. The resul of uni roo es show ha he non-saionary variables exhibi saionary a firs difference and he co-inegraion es resul revealed ha here exiss one co-inegraing equaion among he variables. Empirical evidence from he sudy suggess ha deb is saisically significan and has a negaive impac on he economic growh of Bhuan. I is expeced ha if he governmen keep on borrowing hen in he long run he Bhuanese economy may no be able o mainain a susainable economic developmen. We can conclude ha governmen borrowing is no good for he economic growh. Though he Governmen can borrow o finance he developmenal projecs bu he burden from he deb can hamper he growh of a counry. As long as he deb servicing is no cleared and in order o minimize he dependency on deb he governmen should make effor o furher boos and pursue inernal reforms and sources of revenues as a measure o finance is developmenal aciviies. The concerned auhoriy responsible for managing he governmen deb should monior he deb paymen obligaion and assure ha he deb do no cross he ceiling as specified in he public deb policy of Bhuan [29]. REFERENCES [1] Adepoju, A. A., Salau, A. S., & Obayelu, A. E. (2007). The Effecs of Exernal Deb Mangemen on Susainable Economic growh: Lessons from Nigeria. Munich Personal RePEc Archive, (2147), [2] Aluko, F., & Arowolo, D. (2010). Foreign aid, he Third World s deb crisis and he implicaion for economic developmen : The Nigerian experience. Journal of Poliical Science, 4(April), [3] Spilioi, S. (2015). 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