Fiscal Resilience or Vulnerability? Assessing Public Debt Sustainability in the Developing Countries During 1996-2020

Abstract

The topic of public debt sustainability is very relevant in the present context when developing countries are experiencing a continuous rise in their public debt stocks with unprecedented pressures on their primary balances. In such context, we aim in this study to examine public debt sustainability in a large sample of developing countries, using panel fiscal reaction function and panel unit root analysis as well as time series unit root tests for each country over the period 1996-2020. To delve further into the issue, we bifurcate developing countries as lower-middle-income economies and upper-middle-income economies, respectively. Our empirical estimates from the standard regressions (OLS, Sys GMM, and instrumental variable regression) and panel quantile regressions indicate the sustainability of public debt in developing countries and the two subsamples: lower-middle-income economies and upper-middle-income economies over the period under examination. Our time series unit root tests (ADF and PP) show that developing countries are largely sustainable except for four countries: Pakistan, Sri Lanka, Sudan, and Uganda, implying that although the fiscal response is stronger to the rising public debt ratios in the majority of the developing countries, there are countries in need of fiscal tightening and required to enhance primary balances in order to put their public debt ratios on a sustainable path. We suggest that developing countries need to be prudent in their debt policies, even if their fiscal responses are sustainable, in order to be better prepared for future uncertainties or crises.