Government Debt and Economic Growth in Developing Countries: Macroeconomic Determinants and Non-Linear Threshold Effect

Abstract

This study focuses on the non-linear relationship between government debt and economic growth while investigating the major determinants of government debt. This panel study uses data for 129 developing countries from the World Bank database spanning from 2000 to 2024. The study has used the Method of Moments Quantiles Regression (MMQR) and the Panel Threshold Regression to identify the non-linear effects and optimal point in the debt-growth nexus in developing countries.  The analysis of determinants of government debt using MMQR analysis highlights that GDP growth, trade openness, government expenditures (productive), and institutional quality are positively associated with government debt. While official exchange rates and gross capital formation have been negatively associated with debt, except for inflation, which has a U-shaped association. The estimation of economic growth determinants reveals that labor force participation, gross capital formation, trade, and institutional quality are growth-enhancing factors, while the growth-deteriorating factors are inflation, exchange rate, and government debt.  The study confirms the presence of a non-linear relationship between economic growth and government debt. A threshold point is 18.67% of GDP, where the structural break occurs in the debt-growth relationship. The findings of this study suggested policy recommendations with respect to the low and high debt regimes. The countries in low debt regimes should perform counter-cyclical fiscal policy, regulate the exchange rate, avoid trade and institutional reforms, and cut consumption expenditures. The countries in the high debt regime should focus on trade, public provisions, capital formation, and the rate system to control the government and boost economic growth. The finding of the threshold point suggests a debt ceiling, requires annual reporting of debt accumulation, and links investment with debt planning.