Does External Debt Lead to Growth in the Presence of Quality Institutions?

Debt, domestic as well as external, has always been a part of the lives of nations. Governments borrow to cover budget deficits, invest on physical and human capital in order to kick start the economy and to maintain balance of payments. External debt in particular has grown into importance since the end of the Second World War when international lending organizations such as the Bretton Woods Institutions were established. The stock of external debt owed by low- and middle-income countries reached US $6.7 trillion in 2015. In 2015, external debt accounted for 26 percent of the Gross National Income (GNI) of the low- and middle-income countries and 98 percent of their export receipts. In this study, we intend to examine the role that institutional quality plays in defining the debt-growth relationship. The objective is to understand whether the presence or absence of quality institutions determines and influences the direction and magnitude of debt's effect on growth. The results indicate that the negative effects of external debt on economic growth reported in the literature are limited to countries with poor institutions. Growth in countries with better-quality institutions, in contrast, does not suffer as a result of external borrowings. For other control variables, the results are consistent with the expectations.