Macroeconomic Factors Driving External Debt in Pakistan: The Role of Exchange Rate, Inflation Rate, Fiscal Deficit and Trade Openness

Abstract

The rising external debt of Pakistan has become a serious issue for the policymakers over the past three decades This research analyzes the macroeconomic drivers of external debt in Pakistan from 1995 to 2024, by concentrating on four quintessential variables: inflation rate, exchange rate, trade openness, and fiscal deficit. The main aim of this study to explain how these variables influence the external debt of Pakistan.  The Autoregressive Distributed Lag (ARDL) is utilized to examine the long- and short-term relationship among variables. Diagnostic tests such as multi-collinearity, normality, heteroscedasticity, specification bias and unit root are performed to evaluate the model’s validity.  The result of this research reveals that in long run inflation, and fiscal deficit have statistically significant positive relations with external debt, while exchange rate is significantly negative relationship with external debt. The trade openness has also positive but insignificant relationship with the Pakistan’s external debt. In the short run, exchange rate depreciation and inflation and fiscal deficit constantly fosters external debt.