External Debt

In this section, we briefly review the literature analysing the impact of external debt on economic growth. In economic theory, external debt defined as reasonable levels of borrowing for developing country in order to enhance economic growth as it faster the development infrastructure. When a country has budget deficit, to finance government expenditure and domestic investment, government will borrow from domestic and international markets. Instead of domestic debts, external debt is one of the public debts.

2.1 External Debt

External debt has good impact to economic growth in Malaysia at the aggregate level (Bakar & Hassan, 2008). Country would be faced high probability of suffering the debt-overhang problem if high level debts having opposing effects on economic growth. Debt-overhang problem can be defined as expected repayment of external debt fall short of the promised value of debt (Krugman, 1988). In addition, debt increase in future than the country’s repayment, expected debt-service cost will discourage domestic and foreign investment in future too (Pattillo & Poirson, 2010).

There were researchers who did not support that external debt effects economic growth because of several factors. Greiner (2013) said long run economic growth did not effect by public debt but only stability of the economy. According to what has been stated by Reinhart and Rogoff (2010), Choong, Lau, Liew and Puah (2010) and Alves (2013), high debt gives negative impact on economic development. There were few empirical evidences stated that increasing stock of debt has negative impact on economic growth, this evidences found by Chowdhury (2001), Clements, Bhattacharya and Nguyen (2003), Wijeweera, Dollery and Pathberiya (2005) and Sen and Swapan (2007). Previous research done by Choong (2010) suggested that external debt has negative impact on Malaysia long-run economic growth. According to what has been found by Poirson, Ricci and Pattillo (2004), Cordella, Ruiz-Arranz and Ricci (2005) and Imbs (2005) there was non-linearity in relationship between debt and growth. Moreover, what has been reported by Poirson (2004), average effect of debt on per capita growth seems to become negative for debt levels above 160 to 170 percent of export and for GDP, 35 to 40 percent.

In an IMF Working Paper, Pattillo & Poirson (2010) examined whether debt effect developing economies or not. In the working paper explained about 93 developing countries over the period 1969 to 1998. Both linear and non-linear regression acted as a control for a set of variables common in the growth literature including trade openness and population. In addition, to be surer about definition of debt burden, they used four different kind of definition which is ratios of nominal and net present values of external debt to both exports and gross domestic product. Lastly, debt ratio will reduce annual per capita growth but only for