An Empirical Investigation of Debt Overhang and Liquidity Constraints Hypothesis in South Asian Countries

Abstract

The existence of the phenomenon of twin’s deficits in South Asian countries has now become a common characteristic from the last few decades. Their reliance on debt both external and domestic to bridge thesedeficits has been increasing continuously which results in mounting public debt burden. The positive effect of public debt burden in resource-scarce countries occurs if the debt is utilized optimally and properly in income-generating activities that enhance the productive capacity of the borrower country to repay the debt obligations and its servicing charges. The negative effect of debt works through two main channels, namely “debt overhang” and “crowding out”. The present study aims to investigate the implication of debt overhang and liquidity constraints hypothesis in South Asian countries   i.e.Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, and Sri Lanka. For this purpose, a hybrid model has been
developed and panel data of these countries from 1990 to 2020 has been used. The study uses standard panel data estimation techniques for the estimation of the results. The results obtained confirm the existence of debt overhang and liquidity constraints hypothesis in South Asian economies. Similarly, domestic debt also offsets economic growth and investment. The study suggests that bridging the twin's deficits through public borrowings is not a safe option and efforts will be made to minimize the expenditures and increase the revenues by adopting better strategies.