External Debt and Capital Accumulation Nexus: Evidence from Pakistan

The rising public debt burden is a common feature of developing countries like Pakistan. This study is an attempt to empirically analyse the external debt and capital accumulation nexus for Pakistan from 1972 to 2016. The ARDL bound testing technique was employed to estimate two models which incorporate different indicators of external debt. Results indicate the existence of a negative relationship between external debt to revenue ratio and stock of capital that supports the debt overhang hypothesis for Pakistan. The debt overhang hypothesis states that large accumulated debt leads to a decrease in overall capital accumulation in an economy. Similarly, other indicators of external debt, namely, external debt service to revenue ratio, external debt to export ratio, and external debt service to export ratio tend to bring a fall in stock of capital in Pakistan. Based on its findings, the study suggests the need for better and productive use of external debt in public sector development projects to foster the capital accumulation process in Pakistan.