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1
ANALYSIS OF THE RELATIONSHIP BETWEEN EXTERNAL DEBT AND
ECONOMIC GROWTH IN TANZANIA
By
Tunukiwa Kavana (PPM III)
A Research Report Submitted in Partial Fulfillment of the Requirements
For the Degree of Science in Economics, Project Planning and Management
at
Mzumbe University.
2014
i
CERTIFICATION
We, the undersigned, certify that we have read and hereby recommend for acceptance by
the Mzumbe University, a research report entitled Analysis of the relationship between
external debt and economic growth in Tanzania, in partial fulfillment of the Bachelor
of Science Degree in Economics (Project Planning and Management) of Mzumbe
University.
Dr. Mursali Milanzi
_M.Milanzi______________________
Major Supervisor
ii
COPYRIGHT
I, Tunukiwa Kavana declare that this research report is my own original work and that
it has not been presented and will not be presented to any other University for a similar
or any other degree award.
_T.Kavana_______________________________
Signature
This Research Report is copyright material protected under the Berne Convention, the
Copyright Act of 1999 and other international and national enactments, in that behalf, on
intellectual property. It may not be reproduced by any means, in full or in part, except
for short extracts in fair dealings, for research or private study, critical scholarly review
or discourse with an acknowledgement, without the written permission of the Dean,
Faculty of Social Sciences, on behalf of the author and Mzumbe University.
© Copyright Tunukiwa Kavana
2014
iii
ACKNOWLEGDEMENT
Foremost, I would like to thank the Almighty God, for the skills, fine health and power
he has given me in conducting this study from the beginning to the end.
I am further obliged to a number of people for their outstanding supports all through my
studies at the University of Mzumbe. First and special of all, is to my supervisor Dr.
Mursali Milanzi who was abundantly helpful and offered invaluable assistance, support
and guidance including his willing to listen to my understanding of the subject to a way
that is well organized to its final stage. His open comments and directives together
strengthened the substance of this study. May our almighty God continues blessing him
and extends his longevity for future studies.
More appreciations go to all students at the Mzumbe faculty of social science and more
specifically students of Project Planning and Management class for sharing the literature
and invaluable assistances. May Almighty God remind and guide you to practice all that
you acquired as Economists and hence maintain the reputation of Mzumbe University.
I would also like to convey special thanks to the Tanzania Ministry of Finance
particularly to the Permanent Secretary and the entire Department of Poverty Eradication
(MKUKUTA) for providing conducive field study experience from the beginning of my
field to the end.
Finally, I am happy to express my love and gratitude to my parents Mr. Kaombwe
Kavana and Mrs. Esther Kyomo for their understanding and endless love throughout the
duration of my studies. I am equally grateful to my close and valuable friends for their
support.
iv
DEDICATION I dedicate this work to my parents Mr. Kaombwe Kavana and Mrs. Esther Kyomo
without forgetting my adorable brothers Mr. Ezra Kavana and Mr. Abraham Kavana for
being by my side and supporting me academically and for that am proud to be a good
responsible daughter and a sister.
v
LIST OF ABBREVIATIONS
BOT - Bank of Tanzania
DBB - Debt Buyback Scheme
DCP - Debt Conversion Program
GDP - Gross Domestic Product
HIPCs - Heavily Indebted Poor Countries
IMF - International Monetary Fund
MDF - Multilateral Debt Fund
MDRF - Multilateral Debt Relief Fund
MOF - Ministry of Finance
NBS - National Bureau of Statistics
OLS - Ordinary Least Square
SSA - Sub-Saharan Africa
UNDP - United Nations Development Program
URT - United Republic of Tanzania
USD - United States Dollars
VIF - Variance Inflation Factor
WB - World Bank
vi
ABSTRACT
The purpose of the study was to examine the influence of external debt on
economic growth. The study used time series data collected from various sources such
as Ministry of finance, National Bureau of Statistics and Bank of Tanzania in the years
between 1980-2010. The main method of analysis was regression analysis whereby
Ordinary Least Square Model was used to facilitate the analysis. Selection of this
estimation model was based on the fact that our stochastic process that is GDP was
tested to be stationary.
The findings show that external debt stock affects GDP positively. Th i s means
external debt has positive effect when it is utilized by the Government for investment
oriented projects like power generation and supply, infrastructure, education, health,
production and agriculture sectors. The small magnitude of external debt on economic
growth observed in this study implies that the level of utilization of external debt to
investment projects is very minimal as much have been directed to recurrent
expenditure.
The findings further revealed that real debt service negatively affects GDP growth
because real debt service is the cost that the government incurs from borrowing, if the
government borrow and invest in the development projects such as Health,
Education and infrastructure, that is investing in the projects that brings returns to the
society, the cost of debt is minimized, otherwise the cost increase. The negative
relationship indicates that as the cost of debt increases GDP goes down. But in this study
variable Debt service is not significant probably meaning that as Tanzanian government
being one of the HIPCs countries has been pardoned most of her debts, therefore her
budget is not concentrated much on servicing debts but on other expenses. Also most of
Tanzania debts maturity range from 30 to 40 years which is above the period of study.
vii
Furthermost, the study revealed that there is a positive relationship between FDI and the
economic growth under the period of study. This positive relationship implies that
foreign capital is invested in development projects which expand the economy through
increase in GDP.
Based on the findings, the study recommends that the government should take an
external debt which is productively used as this can guarantee its repayment.
Furthermost, the government is advised to create other optional strategies to improve the
economy for example, formulation and implementation of policies for effective
management of its revenues. These policies should ensure that the revenues that
government collects from especially her internal sources like taxes are directed and used
to finance various development projects which expand the economy. This will reduce
over dependence on the external debt.
viii
TABLE OF CONTENTS
CERTIFICATION ................................................................................................................................ i
COPYRIGHT .................................................................................................................................. i
DEDICATION ................................................................................................................................... iv
LIST OF ABBREVIATIONS ................................................................................................................. v
ABSTRACT ....................................................................................................................................... vi
LIST OF TABLES ................................................................................................................................ x
LIST OF FIGURES ............................................................................................................................. xi
CHAPTER ONE ................................................................................................................................ 1
BACKGROUND OF THE STUDY .................................................................................................... 1
1.0 Introduction ......................................................................................................................... 1
1.1 Background of the Study ...................................................................................................... 1
1.2 Problem Statement .............................................................................................................. 3
1.3 Main Research Objective ..................................................................................................... 5
1.4 Specific Research Objectives ................................................................................................ 5
1.5 Significance of the Study ...................................................................................................... 5
1.6 Limitation of the Study......................................................................................................... 6
CHAPTER TWO ............................................................................................................................... 7
LITERATURE REVIEW .................................................................................................................. 7
2.0 Introduction ......................................................................................................................... 7
2.1 Definition of variables .......................................................................................................... 7
2.1.1 Economic Growth .......................................................................................................... 7
2.1.2 External Debt ................................................................................................................ 8
2.1.3 Debt Service Payment ................................................................................................... 9
2.1.4 Foreign Direct Investment ............................................................................................ 9
2.2 Debt Overhang Theory ....................................................................................................... 10
2.3 Empirical Studies ................................................................................................................ 11
2.4 Conceptual framework ...................................................................................................... 13
Figure 2.1 Conceptual Framework ........................................................................................... 13
2.5 Statement of Hypothesis ................................................................................................... 15
CHAPTER THREE ........................................................................................................................... 16
ix
RESEARCH METHODOLOGY ..................................................................................................... 16
3.0 Introduction ....................................................................................................................... 16
3.1 Research Design ............................................................................................................... 16
3.2 Area of the Study ............................................................................................................... 16
3.2 Data collection ................................................................................................................... 16
3.3 Variables and their measurement ..................................................................................... 17
3.4 Econometric model ............................................................................................................ 18
3.5 Estimation Technique ........................................................................................................ 19
CHAPTER FOUR ............................................................................................................................ 20
PRESENTATION AND DISCUSSION OF FINDINGS ..................................................................... 20
4.0 Introduction ....................................................................................................................... 20
4.1 Descriptive Statistics .......................................................................................................... 20
4.2 Empirical Results ................................................................................................................ 24
4.2.1 Diagnostic Testing and OLS Regression output ........................................................... 24
4.2.2 Analysis of Data ........................................................................................................... 24
4.2.3 A unit root test ............................................................................................................ 24
4.2.4 Regression results ....................................................................................................... 26
4.2.5 Diagnostic test of the overall model ........................................................................... 26
4.2.6 Multicollinearity .......................................................................................................... 26
4.2.7 Detecting for multicollinearity .................................................................................... 27
4.2.8 Interpretation of results .............................................................................................. 27
4.3 Discussion of findings ......................................................................................................... 28
CHAPTER FIVE .............................................................................................................................. 29
CONCLUSION AND RECOMMENDATION ................................................................................. 29
5.0 Introduction ....................................................................................................................... 29
5.1 Summary of the Findings ................................................................................................... 29
5.2 Recommendations ............................................................................................................. 30
REFERENCES ................................................................................................................................. 31
APPENDICES ................................................................................................................................. 33
x
LIST OF TABLES
Table 3.1 Summary of Variables.....................................................................................18
Table 4.1 Matrix Correlation............................................................................................21
Table 4.2 Augmented Dicker Fuller test (ADF) Results..................................................23
Table 4.3 Results after correcting the test.......................................................................24
Table 4.4 Regression results.............................................................................................25
Table 4.5 VIF results……………………………………………………………………27
xi
LIST OF FIGURES
Figure 1.1 Tanzania Government Debt to GDP.................................................................3
Figure 2.1 Conceptual framework...................................................................................14
Figure 4.1 Scatter plot between GDP and external debt stock.........................................19
Figure 4.2 Scatter plot between GDP and debt service....................................................20
Figure 4.3 Scatter plot between GDP and foreign direct investment...............................21
1
CHAPTER ONE
BACKGROUND OF THE STUDY
1.0 Introduction
This chapter consists of background of the problem, statement of the problem, objective
of the study, significance of the study and limitation of the study.
1.1 Background of the Study
From mid 1960’s to mid 1980’s Tanzanian government pursued economic and social
policies under the umbrella of the Arusha Declaration which emphasized on socialist
principles of economic management. According to URT (1998), the country made
progress in economic and social development, as GDP growth averaged 4.7 percent per
annum from 1968 to 1978. However, starting from 1979 to early 1980s the average
GDP growth rate dropped drastically as the economy was faced with multifaceted
economic problems characterized by large fiscal deficits, declining real per capita
income and erosion of the tax base.
From early 1970s Tanzania started encountering a series of economic and natural
setbacks which led to a build-up of huge fiscal and balance of payments deficits, which
in turn necessitated the Government to borrow heavily. As a result, external
indebtedness rose from USD 4.9 billion in 1986 to USD 7.9 billion in 1997 while debt
arrears increased sharply from USD 0.66 billion to USD 3.1 billion, respectively. By
December 1997 bilateral debt accounted for 44.4 percent of the debt stock, while
multilateral debt, private and commercial accounted for 48 percent and 8 percent
respectively (URT, 1998)
Factors which contributed to the acceleration of the debt crisis in Tanzania are both
domestic and external in nature. They included inappropriate socio-economic policies,
oil price shocks, droughts, implications of the break-up of the East African Community,
2
unfavorable terms of trade and the influx of refugees and the war between Tanzania and
Uganda in 1970s.
To deal with the problem of drastic rise in external debts from the late 1980s Tanzania
like other Highly Indebted Poor Countries (HIPCs) negotiated specific arrangements in
the framework of the Economic Recovery Programme which started in 1986 aiming at
reducing these debts. The first arrangement is the Bilateral Debt Relief where from mid -
1970s Tanzania Government requested bilateral creditors to cancel official loans and up
to mid-1997 total debts worth US$ 1,044 million were cancelled (URT, 1998)
The second arrangement was Paris club debt relief were Tanzania has been to Paris
Club five times since 1986 to request for debt relief and Debts worth US$ 523.8 million
were cancelled and US$ 1,918.7 million were rescheduled by 1997. The third
arrangement was debt conversion programme where debts worth USD 182.0 million
were converted between 1990 -1993 and the proceeds were re-invested in 82 projects.
This programme was suspended due to its inflationary impact and in order to pave way
for the Debt Buyback scheme which is considered to be non-inflationary (URT, 1998)
Debt buy back scheme followed in 1998 where debts worth USD 23 million were
extinguished from the IDA debt reduction facility. In April 1998, the Government of the
United Republic of Tanzania established a Multilateral Debt Relief Fund (MDRF), so as
to bring relief both to the budget and balance of payments. The relief expected in terms
of foreign resources would be used to service debts owed to Multilateral Financial
Institutions, while the budgetary relief would be used to finance poverty reduction
programs in the social sectors (URT, 1998)
Despite the debt reduction initiatives, Tanzania has not been able to service its debts as
scheduled due to poor economic performance of these initiatives as stated by the World
Bank (2011), as up to year 2011 Tanzania had an external debt of about more than 7.9
billion dollars and servicing of this debt absorbs about 40% of the total government
expenditures yearly.
Figure 1.1 Tanzania Government Debt to GDP
Source : Bank of Tanzania
From figure 1 above, Tanzania recorded a Government Debt to GDP of 47.70 percent of
the country's Gross Domestic Product in 2012. Government Debt to GDP in Tanzania is
reported by the Bank of Tanzania. From 2002 until 2012, Tanzania Government Debt To
GDP averaged 50.9 Percent
2002 and a record low of 35.0 Percent in December of 2008.
1.2 Problem StatementFaraji and Said (2012) stated in their study that d
1950s, deficits in the c
encouraged to borrow abroad and create an environment conducive for foreign
investment to boost their economic growth. In the process
liabilities side of the current ac
these countries, until when Mexico, despite being an oil exporter, declared in August
1982, that it could not service her debts. Ever since, the issue of external debt and its
servicing has assumed critical importance and introduced the 'debt crisis' debate.
3
Tanzania Government Debt to GDP
Source : Bank of Tanzania
Tanzania recorded a Government Debt to GDP of 47.70 percent of
the country's Gross Domestic Product in 2012. Government Debt to GDP in Tanzania is
reported by the Bank of Tanzania. From 2002 until 2012, Tanzania Government Debt To
GDP averaged 50.9 Percent reaching an all time high of 66.6 Percent in December of
2002 and a record low of 35.0 Percent in December of 2008.
Problem Statement stated in their study that during the three decades beginning in the
deficits in the current account were considered normal. Countries were
encouraged to borrow abroad and create an environment conducive for foreign
investment to boost their economic growth. In the process, little attention was paid to the
liabilities side of the current account deficit which increased the external indebtedness of
these countries, until when Mexico, despite being an oil exporter, declared in August
could not service her debts. Ever since, the issue of external debt and its
critical importance and introduced the 'debt crisis' debate.
Tanzania recorded a Government Debt to GDP of 47.70 percent of
the country's Gross Domestic Product in 2012. Government Debt to GDP in Tanzania is
reported by the Bank of Tanzania. From 2002 until 2012, Tanzania Government Debt To
reaching an all time high of 66.6 Percent in December of
uring the three decades beginning in the
normal. Countries were
encouraged to borrow abroad and create an environment conducive for foreign
little attention was paid to the
count deficit which increased the external indebtedness of
these countries, until when Mexico, despite being an oil exporter, declared in August
could not service her debts. Ever since, the issue of external debt and its
critical importance and introduced the 'debt crisis' debate.
4
Gohar et al. (2012) mentioned that the repayment or “debt service” creates problems for
many countries especially for developing countries because debts which are to be
serviced are more than the actual amount it was taken for. Therefore, large debt service
payments impose a number of constraints on a country’s growth scenario. Either, it
drains out limited resources and restricts financial resources for domestic need of
development of these countries.
Claessens et al .( 1996) explains in his study that, when the accumulated debt amount
crosses the threshold level of a country’s repayment capacity, the expected default may
cause the domestic and foreign investors to draw back their money; this will negatively
affect the economic growth of the country. This means as the debt stock of a nation
exceeds its future capacity to repay it, investors worry of investing large sums of money
into new business developments as they fear any profits would be taxed away by the
government in the long-term. This negatively affects the economy as fall in investment
decreases economic growth of a nation.
Furthermore, Fosu (2009) found out that debt servicing shifts spending away from the
social sector, health and education. This is shown that the aim of taking debt is behind to
seek development than being depressed by debt service payments because it cuts up
most of the resources rather than development. As a result creates a great hindrance in
the economic growth of a country due to high interest payments on the external debt,
heavy public expenditures and foreign exchange to repay that debt.
While previous studies brought up arguments against external borrowing, Benedict et al.
(2003) suggested that foreign borrowing has a positive impact on investment and growth
of a country up to a threshold level but external debt service can potentially affect the
growth as most of the funds will go in the repayment of the debt rather at the
investments.
5
According to World Bank (2011) Tanzania had an external debt of about more than 7.9
billion dollars and servicing of this debt absorbs about 40% of the total government
expenditures yearly. This implies that if Tanzania is taking all the great risk to incur
these debts and use almost the large part of her expenditures to service them, there must
be a great deal of relationship between external debt and her economy.
From the summary of various studies which investigated the relationship between
economic growth and external debt stock it is clearly shown that there is a great deal of
debate on whether external debt stock is either positively or negatively related to the
economic growth. Therefore, this study is conducted to examine this relationship
between external debt and economic growth in Tanzania.
1.3 Main Research Objective
To examine the relationship between external debt and the economic growth in
Tanzania.
1.4 Specific Research Objectives
• To find out the relationship between external debt stock and economic growth
• To examine the relationship between debt service payment and economic growth
• To examine the relationship between foreign direct investment and economic
growth
1.5 Significance of the Study
The study is premised on the understanding that Tanzania, like other developing
countries is suffering from debt burden problem. This study constructs a framework for
rationalization of the impact of external debt on economic growth and it is useful for
further studies. The main objective of this study is to investigate the relationship
between external debt and economic growth of Tanzania. Particularly, the question of
interest was whether there is any relationship between external debt and economic
growth of Tanzania. The study used econometric models to determine the relationship.
6
1.6 Limitation of the Study
The major limitation of this study is the inconsistence of the time series data used in this
study as the prime objective for their collection varies from one source to another.
7
CHAPTER TWO
LITERATURE REVIEW
2.0 Introduction
This chapter consists of Theoretical framework, Empirical studies, Conceptual
Framework and Definition of terms used.
2.1 Definition of variables
2.1.1 Economic Growth
The best way to understand a country's economy is by looking at its Gross Domestic
Product (GDP) which is the economic indicator measuring the country's total output. By
definition GDP is the market value of all officially recognized final goods and services
produced within a country in a year, or other given period of time. GDP can be
determined by using three ways which are the income approach, expenditure approach
and production approach.
• Expenditures Approach
By this approach GDP is calculated from the total spending on all final goods
and services, (Consumption goods and services (C) , Gross Investments (I) ,
Government Purchases (G) and (Exports (X) - Imports (M)
GDP = C + I + G + (X-M)
• Income Approach
Using the Income Approach GDP is calculated by adding up the factor incomes
to the factors of production in the economy. These include, National Income
(NY) , Indirect Business Taxes (IBT), Capital Consumption Allowance and
Depreciation (CCA) and Net Factor Payments to the rest of the world (NFP)
8
NY = Employee compensation + Corporate profits + Proprietor's Income +
Rental income + Net Interest
CCA = Igross + Inet (I= Investment)
NFP = Payments of factor income to the ROW minus the receipt of factor
income from the rest of the world.
Thus,
GDP + NFP = GNP （GROSS NATIONAL PRODUCT)
GNP - CCA = NNP ( NET NATIONAL PRODUCT)
NNP - IBT = NY (NATIONAL INCOME)
• Production Approach
Measures the total market value of all final goods and services. The value of
sales of goods - purchase of intermediate goods to produce the goods sold.
In this study GDP will be used to analyze the relationship between external debt and
economic growth.
2.1.2 External Debt
External debt is the part of the total debt in a country that is owed to creditors outside the
country. The debtors can be the government, corporations or citizens of that country.
The debt includes money owed to private commercial banks, other governments, or
international financial institutions such as the International Monetary Fund (IMF) and
World Bank Government debt as a percent of GDP, also known as debt-to-GDP ratio, is
the amount of national debt a country has in percentage of its Gross Domestic Product.
9
Basically, Government debt is the money owed by the central government to its
creditors. There are two types of government debt: net and gross. Gross debt is the
accumulation of outstanding government debt which may be in the form of government
bonds, credit default swaps, currency swaps, special drawing rights, loans, insurance and
pensions. Net debt is the difference between gross debt and the financial assets that
government holds. The higher the debt-to-GDP ratio, the less likely the country will pay
its debt back, and more likely the country is to default on its debt obligations.
2.1.3 Debt Service Payment
Debt service is the sum of principle repayments and interest payments actually paid on
debt to non-residents (World Bank, 2011). It means the sum of principal repayments and
interest payments actually made in the year specified.
2.1.4 Foreign Direct Investment
Foreign direct investment (FDI) is an investment made to acquire a lasting management
interest (normally 10% of voting stock) in a business enterprise operating in a country
other than that of the investor defined according to residency (World Bank, 1996)
This means it is a direct investment into production or business in a country by an
individual or company of another country, either by buying a company in the target
country or by expanding operations of an existing business in that country Broadly,
foreign direct investment includes "mergers and acquisitions, building new facilities,
reinvesting profits earned from overseas operations and intra company loans". In a
narrow sense, foreign direct investment refers just to building new facilities.
The numerical FDI figures based on varied definitions are not easily comparable. As a
part of the national accounts of a country, and in regard to the GDP equation
Y=C+I+G+(X-M)[Consumption + gross Investment + Government spending +(exports -
imports], where I is domestic investment plus foreign investment, FDI is defined as the
10
net inflows of investment (inflow minus outflow) to acquire a lasting management
interest (10 percent or more of voting stock) in an enterprise operating in an economy
other than that of the investor.FDI is the sum of equity capital, other long-term capital,
and short-term capital as shown the balance of payments. FDI usually involves
participation in management, joint-venture, transfer of technology and expertise
2.2 Debt Overhang Theory
Most of economic theories suggest that if the borrowed money by a country is utilized in
effective and efficient manner in the productive investment purposes then it can add
value to the economic growth of that country. On the other hand large amount of
external debt may cause negative effect on the economic growth. This concept is
explained by debt overhang theory which states that, ‘when the accumulated debt
amount crosses the threshold level of a country’s repayment capacity, the expected
default may cause the domestic and foreign investors to draw back their money; this will
negatively affect the economic growth of the country (Claessens et al. 1996) .
This means as the debt stock of a nation exceeds its future capacity to repay it, investors
worry of investing large sums of money into new business developments as they fear
any profits would be taxed away by the government in the long-term .The debt overhang
theory is based on the premise that if debt will exceed the country's repayment ability
with some probability in the future, expected debt service is likely to be an increasing
function of the country's output level.
The theory further implies that some of the returns from investing in the domestic
economy are effectively 'taxed' away by existing foreign creditors and investment by
domestic and new foreign investors is discouraged. Under such circumstances, the
debtor country shares only partially in any increase in output and exports because a
fraction of that increase will be used to service the external debt.
11
This study is based on economic growth and its explanatory variables. The analysis done
on the economic growth and external debt in this study is based on the view that the
external debt of a country has impact on the output. Variable economic growth is related
to external debt stock, debt service payments and the foreign direct investment. The real
gross domestic product growth which is one of the indicators of economic growth and is
taken as the dependent variable. Foreign direct investment, external debts and external
debt service payments are the independent variables under study where the effect of
external debt will be seen individually on the economic growth by employing the
regression model. Therefore, this model will be run to tell the relationship between
external debt and the Tanzanian economy.
2.3 Empirical Studies Many empirical studies have investigated the effect of external debt on economic
growth, some end up finding a negative impact on economic growth while others found
a positive relationship between economic growth and external debt. Most of these
studies have used real GDP and GDP growth rate as dependent variables and tried to
explore the direct impact of external debt on GDP growth rate.
Iyoha (1999), this econometric study takes a simulation approach to investigate the
impact of external debt on economic growth in sub-Saharan African countries using a
small macro-econometric model estimated for 1970-1994 years. An important finding
was the significance of debt overhang variables in the investment equation, suggesting
that mounting external debt depresses investment through both a “disincentive” effect
and a “crowding out” effect. It was found that debt stock reduction significantly
increased investment and growth performance. A 20% debt stock reduction would, on
average, have increased investment by 18% and increased GDP growth by 1% during
the 1987-1994 period. Thus, the results demonstrate that debt forgiveness could provide
a much needed stimulus to investment recovery and economic growth in sub-Saharan
Africa.
12
Ajayi and Oke (2012), investigated the effect of the external debt burden on economic
growth and development of Nigeria .It adopted regression analysis of OLS on secondary
data sourced from CBN, Economical and Financial review, Business times, Financial
Standard and relevant publication from Nigeria on variable like National Income, Debt
Service Payment, External Reserves, Interest rate among others. The finding indicated
that external debt burden had an adverse effect on the nation income and per capital
income of the nation. High level of external debt led to devaluation of the nation
currency, increase in retrenchment of workers, continuous industrial strike and poor
educational system. This led to the economy of Nigeria getting depressed. Based on the
finding the study suggested that debt service obligation should not be allowed to rise
than foreign exchange earnings and that the loan contracted should be invested in
profitable venture, which will generate a reasonable amount of money for debt
repayment.
Abid, Hammad and Muhammed (2008), analysed the long-run and short-run
relationships between external debt and economic growth of Pakistan. By fitting
production function model to annual data for the period 1970-2003, the study examined
the dynamic effect of GDP, debt service, capital stock and labour force on the economic
growth of the country. The results show that debt servicing burden had a negative effect
on the productivity of labor and capital, and thereby affect economic growth adversely.
Results also show that debt service ratio tends to affect negatively GDP and thereby the
rate of economic growth in the long-run, which, in turn, reduces the ability of the
country to service its debt. Similarly, the estimated error correction term shows the
existence of a significant long-run causal relationship among the specified variables.
Overall, the results point to the existence of short-run and long-run causal relationship
running from debt service to GDP.
Faraji and Said (2012), investigated the impact of external debt on economic growth of
Tanzania for the period of 1990-2010. The study used time series data on external debt
13
and economic performance. It is assumed that external debt helps developing countries
to meet developing needs. The study collected data from Bank of Tanzania (BOT),
President’s Office Finance, Economy and Development Planning in Zanzibar and
Tanzania Ministry of Finance (MOF). In addition, data were collected from the World
Bank (WB) and International Monetary Fund (IMF) publications. The study revealed
that there is significant impact of the external debt and debt service on GDP growth. The
total external debt stock has a positive effect of about 0.36939 and debt service payment
has a negative effect of about 28.517.
To sum up, the prime objective of these studies reviewed here is to explore the empirical
evidence regarding the dynamic relationship between external debt and economic
growth. Some of the studies concluded there is positive relationship between external
debt and economic growth while others stated that there is negative relationship between
external debt and economic growth. Presence of this contradiction whether there is a
positive or negative relationship between economic growth and external debt is the main
aim of conducting this study which seeks to examine the relationship between external
debt and economic growth in Tanzania.
2.4 Conceptual framework
Figure 2.1 Conceptual Framework
14
INDEPENDENT VARIABLES
The conceptual framework above shows the relationship between economic growth as
the dependent variable and external debt stock, debt service and foreign direct
investment as the independent variables. From the debt overhang theory explained in
previous chapter of this study, economic growth has a negative relationship with
external debt stock in a way that as the stock of external debt of a nation exceeds its
future capacity to repay it, investors worry of investing large sums of money into new
business developments as they fear any profits would be taxed away by the government
in the long-term.
Therefore, this drop of foreign direct investment due to external debt increase is the one
that results to fall in economic growth. On the aspect of debt service, economic growth
is affected negatively by the debt service in the way that when government funds are
FOREIGN DIRECT INVESTIMENT
DEBT SERVICE PAYMENT
ECONOMIC GROWTH
EXTERNAL DEBT
DEPENDENT VARIABLE
15
directed more to service external debts instead of being invested to various development
projects the economic growth falls.
2.5 Statement of Hypothesis The hypothesis stated in null form to be tested in this study is as follows.
Ho: External debt has no significant relationship with the economic growth in Tanzania
Ho: Debt service payment has no significant relationship with economic growth in
Tanzania
Ho: Foreign direct investment has no significant relationship with economic growth in
Tanzania
16
CHAPTER THREE
RESEARCH METHODOLOGY
3.0 Introduction
This section represents a systematic analysis of the research techniques that will be used
in the study. The methodology includes the choice of the research design and data
collection techniques.
3.1 Research Design
A research design is the arrangement of conditions for collection and analysis of data in
a manner that aims to combine relevance to the research purpose with the economy
(Kothari, 2004). The study used secondary time series data collected from sources like
Bank of Tanzania, IMF and World Bank.
3.2 Area of the Study
The study was conducted at the Tanzanian Ministry of Finance’s offices in Dar es
salaam, because almost all information regarding debts records and management in
Tanzania are kept there. Therefore researcher participated in the day to day activities at
the ministry while at the same time collecting the required data. Apart from the ministry
of finance other data of the study were collected from NBS, Bank of Tanzania., IMF and
World Bank development reports.
3.3 Data collection The approach used in this study in the data collection is the analysis of secondary data in
search of the evidence that either supports or does not support the theoretical
propositions. The data used in this study are time series data ranging from 1980-2010
collected from various sources such as Ministry of finance, National Bureau of Statistic
Bank of Tanzania and World Bank reports.
17
3.4 Variables and their measurement Dependent variables: Economic growth is the dependent variable in the study which is
the increase in the capacity of an economy to produce goods and services, compared
from one period of time to another. It measured from the gross domestic product
collected covering the period of study expressed in US dollars.
Independent variables: External debt stock is the main independent variable in the study
measured from the external debt stock inflows expressed in US dollars. Moreover this
study used other independent variable which is debt service, the sum of principle
repayments and interest payments actually paid on debt to non-residents. Debt service is
measured by debt service ratio measured from the amount of debt interest payments to
the country’s export earnings. Another independent variable used in the study is the
foreign direct investment measured from the sum of equity capital and reinvestment of
earnings inflows collected covering the period of study expressed in US dollars.
Table 3.1 Summary of variables
Variable Conceptual definition
Measurement Sources of Information
Economic growth An increase in the capacity of an economy to produce goods and services, compared from one period of time to another
Economic growth is measured in terms of Gross domestic product (GDP) which is the market value of all officially recognized final goods and services produced within a country during the period of study.
World Bank development report
External debt stock
It is the part of the total debt in a
It is measured from external debt stock
Tanzania Ministry of finance, National
18
3.5 Econometric model The model of the study is,
Y = βo + β1 X1 + β2 X2 + β3 X3
Whereas,
Y- Economic growth
X1- External debt stock
X2- Debt service
X3- Foreign direct investment
country that is owed to creditors outside the country.
inflows in Tanzania during the period of study
board of statistics
Debt service It is the sum of principle repayments and interest payments actually paid on debt to non-residents.
Debt service is measured by debt service ratio which is ratio of amount of debt interest payments to the country’s export earnings.
Tanzania Ministry of finance and National Board of Statistics
Foreign direct investment
An investment made to acquire a lasting management interest (normally 10% of voting stock) in a business enterprise operating in a country other than that of the investor
It is measured from the sum of equity capital and reinvestment of earnings inflows in Tanzania during the period of study
World Bank development report and Bank of Tanzania
19
3.6 Estimation Technique Ordinary Least Square (OLS) has been used for estimating the econometric model. OLS
technique is used to estimate the slope coefficients of the model. The use of OLS relies
on the stochastic process being stationary. When the stochastic process is non-stationary,
the use of OLS can produce invalid estimates. These estimates are called 'spurious
regression' results with high R2 values and high t-ratios yielding results with no
economic meaning. Estimation was done by using stata where total 31 observations
were included from 1980 to 2010 to find out the relationship between external debt
stock and economic growth.
20
CHAPTER FOUR
PRESENTATION AND DISCUSSION OF FINDINGS
4.0 Introduction
This chapter presents discuss the findings of the study and estimation results of the
study. It also covers the descriptive and empirical analysis of the model. Section 4.1
presents descriptive statistics, section 4.2 presents empirical results of the estimated
models and section 4.3 presents the discussion of the findings.
4.1 Descriptive Statistics
In this section the study uses the correlation analysis to explain the linear relationship
between two variables. This analysis is used to measure the strength of association
(linear relationship) between the independent and dependent variables. Scatter plot
diagrams are used to show this relationship as follows.
Figure 4.1 Scatter plot between GDP and external debt stock
01.
00e+
072.
00e+
073.
00e+
07G
DP
0 5000000 1.00e+07 1.50e+07External debt stock
21
From the above graph, there is a linear relationship between GDP and external debt as
the linear arrangement of the dots. This means GDP and external debt stock are
correlated.
Figure 4.2 Scatter plot between GDP and debt service
The graph above shows that there is no relationship between GDP and debt service due
to the non-linear arrangement of the dots. This means GDP and debt service variables in
this study are not correlated.
01.
00e+
072.
00e+
073.
00e+
07G
DP
50 100 150 200 250 300Debt service
22
Figure 4.3 Scatter plot between GDP and foreign direct investment
There is linear relationship between GDP and foreign direct investment from the figure 5
above. This means there is correlation between the two variables.
4.1.1 Matrix correlation Correlation is a statistical measure that indicates the extent to which two or more
variables fluctuate together. A positive correlation indicates the extent to which those
variables increase or decrease in parallel, a negative correlation indicates the extent to
which one variable increases as the other decreases. Matrix correlation was performed
by using pair wise correlation with 5% level of significance among the independent
variables themselves and dependent variable with independent variables. Correlation
matrix measures the strength and direction of variables. Correlation coefficient equal to
1 indicates perfect correlation, 0.99 to 0.8 indicates strong correlation, 0.79 to 0.50
indicates moderate correlation, 0.49 to 0.30 indicates weak correlation and 0.29 to 0.00
01.
00e+
072.
00e+
073.
00e+
07G
DP
0 2.000e+09 4.000e+09 6.000e+09 8.000e+09Foreign direct investment
23
indicates possible correlation which mainly means there is no correlation between
variables.
Table 4.1 Matrix Correlation
Economic growth
External debt Debt service Foreign direct investment
Economic growth
1.0000
External debt
0.8841* 1.0000
Debt service 0.3487 0.5314* 1.0000
Foreign direct investment
0.9960 0.8892* 0.3316 1.0000
* sign - Level of significance at 5%
Pair wise correlation shown on table 4.1 indicates that economic growth variable is
positively strong correlated with external debt stock at 0.8841. Economic growth is
positively weak correlated with variable debt service at 0.348. Foreign direct investment
and economic growth are positively strong correlated at 0.9960.
On the aspect of significance of variables variable external debt is statistically
significant at 5% level of significance indicated by a star sign on the correlation
coefficient 0.8841*. According to the pair wise correlation results variables debt service
and foreign direct investment are not statistically significant at 5% level of significance
indicated by lack of star sign on their correlation coefficients.
In addition pair wise correlation performed above indicates that there is no problem of
multicollinearity between the independent variables as it is verified by low level of
correlation between independent variables.
24
4.2 Empirical Results
4.2.1 Diagnostic Testing and OLS Regression output Various statistical tests were conducted before model estimation, these include a unit
root test for stationarity which is a pre-estimation test to avoid spurious regression
results whereas, VIF test for testing the problem of multicollinearity was conducted as
post-estimation test after model estimation.
4.2.2 Analysis of Data The analysis starts with arranging the data set in hand in form of time series; this is done
by adding t which takes values of 1 to 30. This results to the following from the stata
output,
tsset year, yearly
time variable: years, 1980 to 2010
4.2.3 A unit root test In statistics, a unit root test, tests as to whether a time series variable is stationary or
non-stationary. A well-known test which is the Augmented Dickey–Fuller test was used
for this purpose to test whether our stochastic process is stationary or non-stationary.
The study used this test in order to decide which estimation technique is to be used as
this is because when the stochastic process is non- stationary the use of OLS can
produce spurious results. The null hypothesis is that the series has unit root while the
alternative hypothesis is that the series has no unit root, thus
Ho=Unit root (Non-stationarity)
Hi=No unit root
Thus if we reject null hypothesis hence is stationary time series with zero mean and if
we accept the null hypothesis hence is non stationary. The following are the results after
the unit root test was done to the time series data collected.
25
Table 4.2 Augmented Dicker Fuller test (ADF) Results
Variables Z(t) Test statistic Critical value at 1%
Critical value at5%
Result
Economic growth 0.0005 -4.265 -3.716 -2.986 Stationary
External debt stock 0.0013 -4.032 -3.716 -2.986 Stationary
Debt service 0.3648 -1.832 -3.716 -2.986 Non-stationary
Foreign direct Investment
0.9764 0.281 -3.716 -2.986 Non-stationary
Since the results after unit root test show that variables debt service and foreign direct
investment are non-stationary as the Z(t) values are greater than 0.0000 thus makes it
insignificant at both 1% and 5%. Therefore to avoid the spurious regression problem that
may arise from regressing a non-stationary time series, we have to make the variables
stationary by taking the first difference of such time series, and hence the following are
the results, after the transformation.
Table 4.3 Results after correcting the test
Variables Z(t) Test statistic Critical value at 1%
Critical value at5%
Result
Economic growth 0.005 -4.265 -3.716 -2.986 Stationary
External debt stock 0.0013 -4.032 -3.716 -2.986 Stationary
Debt service 0.0000 -7.329 -3.723 -2.989 Stationary
Foreign direct Investment
0.0187 -3.222 -3.723 -2.989 Stationary
Hence from the above results, the outcome shows that the Z (t) values are zeros which
shows that the variables are stationary. As long as the time series was not stationary,
then it was not reliable, hence researcher decided to differentiate the variables so as to
make the data set more reliable and ready for analysis.
Therefore in order for the study to come up with a reliable model the study decided to
regress lngdp on lnexternaldebtstock, d.lndebtservice and d.lnforeign directinvestment.
26
4.2.4 Regression results Table 4.4 Regression results
Variable Coefficient P-value
External debt stock 1.186142 0.000
Debt service -0.3113241 0.126
Foreign direct investment 0.2945722 0.026
Constant -7.218758 0.000
Number of observation 31
R-squared 0.9888
Table 4.4 above shows the summary of the findings from the stata output were it
presents coefficients, p-values and R-squared of the regression output.
4.2.5 Diagnostic test of the overall model From the regression results, some of the variables are seen insignificant. This may
suggest that maybe there is the problem with the model like multicollinearity between
the variables. Therefore the VIF test for multicollinearity test was done in order to
diagnose the problem of multicollinearity.
4.2.6 Multicollinearity When there is a perfect linear relationship among the predictors, the estimates for
regression model cannot be uniquely computed. The term collinearity implies the two
variables are near perfect linear combinations of one another. When more than two
variables are involved it is often called multicollinearity, although the two terms are
often used interchangeably. The main concern is that as the degree of multicollinearity
increases the regression model estimates of the coefficients become unstable and the
standard errors for the coefficients can get widely inflated.
27
4.2.7 Detecting for multicollinearity The study used the VIF command after regression to check for multicollinearity, VIF
stands for Variance Inflation Factor. As a rule of thumb, a variable whose vif >10 may
lead to further investigation, as it detect the presence multicollinearity. Tolerance is 1/vif
which show the degree of collinearity, a tolerance value of 0.1 is the same with vif
values=10.The following are results after testing for multicollinearity.
Table 4.5 VIF results
Variable VIF 1/VIF
External debt stock 1.12 0.890980
Foreign direct investment 1.11 0.901169
Debt service 1.01 0.987930
Mean VIF 1.08
From the above results it shows that there is no problem of multicollinearity between the
variables as VIF<10 which is 1.08.
4.2.8 Interpretation of results External debt stock: A 1% increase in the external debt stock on average leads to 1.19%
increase in GDP at ceteris paribus. External debt stock is statistically significant at the
5% level of significance as the P-value equals to 0.0000. These results imply that there is
a significant positive relationship between external debt stock and economic growth.
Foreign Direct Investment: Other things remaining constant a 1% decrease in foreign
direct investment leads to 0.29% increase in GDP. Foreign direct investment is
statistically significant at 5% level of significance as the P-value equals to 0.026. This
observation implies that there is a significant positive relationship between FDI and the
economic growth under the period of study which is from 1980 to 2010.
28
Debt service: The 1% decrease in debt service leads to the 0.31% decrease in GDP. Debt
service variable is not statistically significant at both 1% and 5% level of significance as
the P-value is 0.126 above 0.01 and 0.05 level of significance. As variable debt service
is not statistically significant it means that there is no relationship between debt service
and GDP in the period of this study.
4.3 Discussion of findings Results from the regression output show that in the period of study there is positive
relationship between external debt stock and economic growth. This implies that
external debts which are incurred by Tanzanian government are invested in various
development projects like road construction which in turn provide employment
opportunities and hence boost the economy. Also for developing countries to qualify for
loans from the International financial institutions, IMF and World Bank, their gross
domestic product must be increasing. This condition has resulted to the increase in
economic growth through GDP relative to the external debt stock in the developing
countries. The results of this study are consistent with Faraji and Said (2012) who
investigated the impact of external debt on economic growth of Tanzania for the period
of 1990-2010.
Musau (2010), revealed in his study that foreign direct investment significantly
contributed to the Kenyan economic growth during the period of study. The study used
time series data span from 2000 to 2009 using granger causality estimation method.
Kim’s study is consistent with this study as both have came up with positive relationship
between foreign direct investment and economic growth. The findings imply that the
foreign direct investment affects positively Tanzania economy as the foreign capital is
invested in development projects which expand the economy through increase in GDP.
29
CHAPTER FIVE
CONCLUSION AND RECOMMENDATION
5.0 Introduction
This section presents the conclusion and recommendation based on the research
findings.
5.1 Summary of the Findings
The purpose of the study was to examine the influence of external debt to the
annual growth rate of GDP. The main method of analysis was regression analysis
whereby Ordinary Least Square Model was used to facilitate the analysis. Selection of
this estimation model was based on the fact that our stochastic process that is GDP
was tasted to be Stationary. Time Series data ranging from 1980-2010 were collected
from various sources such as Ministry of finance, National Bureau of Statistics and
Bank of Tanzania.
The results of the findings show that the variable stock of external debt affects GDP
positively. This means stock of external debt have positive effect when it is utilized
by the Government for investment oriented projects like power generation and supply,
infrastructure, education, health, production and agriculture sectors. Furthermore, the
small magnitude of contribution observed in this study implies that the level of
utilization of external debt to investment projects is very minimal as much has been
directed to recurrent expenditure.
The findings further revealed that the variable real debt services negatively affect GDP
growth this is because real debt service is the cost that the government incurs from
borrowing. If the government borrows and invest in the development projects
such as Health, Education and infrastructure, that is investing in the projects that bring
returns to the society, the cost of debt is minimized, otherwise the cost increase.
The negative relationship indicates that as the cost of debt increase then GDP goes
30
down. But in this study variable debt service was not significant probably meaning that
as Tanzania government being one of the HIPCs countries has been pardoned most of
her debts, therefore her budget is not concentrated much on servicing debts but on other
expenses. Also most of Tanzania debts maturity range from 30 to 40 years which is
above the period of study.
The findings further imply that there is a positive relationship between FDI and
Tanzania economic growth under the period of study which is from 1980 to 2010. This
positive relationship implies that the foreign capital is invested in development a project
which expands the economy through increase in GDP.
5.2 Recommendations
External debt is a very important area in any country for boosting the economic
activities. It is a contradiction whether external debt stimulates economic growth or
hinders growth. Some researchers found positive relationship and some negative
relationship between external debt and economic growth for different economic
condition.
Higher indebtedness can affect growth rate through different channels. Hence, based on
the findings of this study it is recommended that the government should ensure to take
an external debt which is productively used and the rate of return of debt must be higher
than the service payment rate. Furthermost, the government is advised to create other
optional strategies to improve the economy for example, formulation and
implementation of policies for effective management of its revenues. These policies
should ensure that the revenues that government collects from especially her internal
sources like taxes are directed and used to finance various development projects which
expand the economy. This will reduce over dependence on the external debt.
31
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Iyoha A. M (1999). External debt and economic growth in Sub-Saharan African
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2013
33
APPENDICES
� The following table shows the collected data from the years 1980 to 2010
showing GDP, FDI, Debt service payments and External debt stock in millions
USD.
Years GDP External debt stock Debt service Foreign direct investment
1980 7933.944 25156.8672 51.8 75890000
1981 9944.944 38572.3623 53.5 77700000
1982 20551.787 58236.6055 63 79500000
1983 26686.62788 76540.88592 57 86600000
1984 34471.49316 109111.5572 63 87500000
1985 44717.91936 155638.1768 61 88348700
1986 110225.8087 186704.9741 76 90450000
1987 177833.9806 377458.9129 83 92700000
1988 321070.0413 649869.2408 88.8 95720000
1989 681904.254 901614.1996 72.3 97020000
1990 831894.458 1259196.801 98.4 99100000
1991 1112238.6 1470242.994 134.7 101400000
1992 1437937.5 2081814.375 227.9 210500000
1993 1764816.65 2802763.613 219.8 485000000
1994 2298703.68 3679870.012 243.6 625300000
1995 3020700.456 4233236.458 225.9 971100000
1996 3767790.2 4255435.64 257.1 1101000000
1997 4799332.71 4434014.788 154.2 1323000000
1998 6211737.158 4985035.967 278.2 1520900000
1999 7254954.104 5911267.007 189.4 1992200000
2000 8155759.251 5751290.38 155.9 2676600000
2001 9100274.68 5701994.242 104.1 2867300000
2002 10444507.14 6903125.431 144.2 2939400000
2003 12107058.66 7600884.474 117.1 3590300000
2004 13972426.52 9398002.149 149.9 3954200000
2005 15877111.13 9430425.147 157.1 4438700000
2006 17941266.84 5127717.301 167.9 4827100000
2007 20742525.71 6234558.075 169.1 5950000000
2008 24781450.2 7191747.662 179.9 6239900000
2009 28212381.65 10066177.13 180.1 8566600000
34
2010 32294236.34 11865476.69 180.9 8762200000
Source: Tanzania Ministry of Finance, BOT, World Bank reports and NBS
� Regression Stata-output results
Source | SS df MS Number of obs = 31
------------- +------------------------------ F( 3, 27) = 792.58
Model | 197.494947 3 65.8316489 Prob > F = 0.0000
Residual | 2.24261525 27 .083059824 R-squared = 0.9888
------------- +------------------------------ Adj R-squared = 0.9875
Total | 199.737562 30 6.65791873 Root MSE = .2882
------------------------------------------------------------------------------
Lngdp | Coef. Std. Err. t P>|t| [95% Conf. Interval]
------------- +----------------------------------------------------------------
lnexternal~k | 1.186142 .0806356 14.71 0.000 1.020692 1.351593
lndebtserv~e |
D1 .| -.3113241 .1971092 -1.58 0.126 -.7157587 .0931105
lnforeignd~t |
D1. | .2945722 .0616945 4.77 0.026 .1679855 .4211589
_cons | -7.218758 .7611016 -9.48 0.000 -8.78041 -5.657107
35
� Matrix correlation Stata-output results
pwcorr, star(5)
| years gdp extern~ k debtse~ e foreig~t
-------------+---------------------------------------------
years | 1.0000
gdp | 0.8888* 1.0000
externalde~k | 0.9433* 0.8841* 1.0000
debtservice | 0.5915* 0.3487 0.5314* 1.0000
foreigndir~t | 0.8853* 0.9960* 0.8892* 0.3316 1.0000
