Impact of Economic Freedom on External Debt: The Case of South Asia

Abstract

The objective of this study is to empirically examine the relationship between economic freedom and external debt in South Asian countries using annual panel data from 2000 to 2023. Short- and long-run dynamics are investigated using panel unit root tests, Pedroni and Johansen cointegration techniques, and the panel ARDL model. The results indicate a significant adverse effect of economic freedom on external debt, showing that a one-unit increase in the Economic Freedom Index decreases external debt by approximately 7.94% in the long run, with a probability of 0.01. Descriptive statistics show that South Asian economies have a moderate level of economic freedom (average score 6.13) and that debt levels vary enormously from US$0.21 billion to US$647 billion, indicating sharp differences in debt sustainability. The ARDL results also indicate that the exchange rate depreciation coefficient (2.69, with a probability of less than 0.01) and corruption (coefficient 0.24, with a probability of less than 0.05) exacerbate external debt. Additionally, political stability has a weak negative impact, with a coefficient of -2.31 and a probability less than 0.10. Trade openness exhibits an effect, with a long-run coefficient p-value of 0, but it is insignificant in the short run. The error correction, with a coefficient of -0.316 and a significance level of 0.05, supports a long-run adjustment toward equilibrium. These results suggest that institutional quality and economic freedom play an important role in external debt management in South Asia.