Biqiong ZHANG, Muhammad DAWOOD, Ahmed AL-ASFOUR / Journal of Asian Finance, Economics and Business Vol 7 No 11 (2020) 607–617 607 607 Print ISSN: 2288-4637 / Online ISSN 2288-4645 doi:10.13106/jafeb.2020.vol7.no11.607 External Debt and Economic Growth: A Dynamic Panel Study of Granger Causality in Developing Countries* Biqiong ZHANG 1 , Muhammad DAWOOD 2 , Ahmed AL-ASFOUR 3 Received: August 01, 2020 Revised: October 11, 2020 Accepted: October 15, 2020 Abstract This study investigates the causal relationship between public and private external debt and economic growth in developing countries. Our model includes 18 selected Asian developing and transition economies from 1995 thru 2019. We employ the dynamic heterogeneous panel data methods, pooled mean group (PMG), robust cross-sectional augmented autoregressive distributed lag (CS-ARDL), and pairwise panel causality test. The results of PMG and CS-ARDL show the existence of causality between external debt and economic growth both in the short-run and long-run. The pairwise Granger causality test found the bidirectional causal relationship runs from total external debt, public external debt, and private external debt to economic growth and economic growth to external debt. The results showed first the existence of causality in the short-run and long-run between external debt and economic growth and the second, bi-directional causality that runs from external debt to economic growth and economic growth to external debt. Both the dynamic models and robust estimator found the same inferences about the impact of main variables on economic growth in Asian developing and transition economies. The findings of this study suggest to assure debt management, investment in productive sectors, increase domestic savings, decrease external dependency, and focus on international trade. Keywords: External Debt, Economic Growth, Asia, Granger Causality, Pooled Mean Group JEL Classification Code: F34, H63, G51, N15, P45 growth have been debated for many decades. Developing countries have failed to bridge the gap between savings and investment, revenue, and expenditure due to a lack of capital or mismanagement of domestic resources. Low economic growth, high unemployment, poverty, inequality are the major problems in developing countries. The external debt financing is considered one of the significant sources to balance the twin deficits and dual gaps for economic growth (Senadza, Fiagbe & Quartey, 2018; Ncanywa & Masoga, 2018; Joy & Panda, 2019; Ngo & Nguyen, 2020a). Before the 1970s, the role of external debt was not harmful and not a problem until the 1980s. Before the 1970s, developing countries borrowed a relatively small amount of external funds from foreign governments, IMF, World Bank, and regional development banks. In that period, the interest rates were low at concessional terms, and resources of inflows were mostly bilateral grants and multilateral aids (Soydan & Bedir, 2015). However, after the 1970s, the oil crisis started, and commercial banks started lending, then high accumulated debt and debt servicing burden became significant factors influencing economies. From this turning point forward, developing countries began to face many global macroeconomic challenges and imbalances 1. Introduction The theoretical and empirical studies on the existence and direction of causality between external debt and economic *Acknowledgements: [1] We thank Mr. Abbas Shah, PhD Scholar, School of Economics, Zhongnan University of Economics and Law, Wuhan China and the editor of this journal for their constructive comments on first draft of this paper. [2] There is no conflict of interest among the authors 1 First Author. Professor, Department of International Finance, Central University of Finance and Economics Beijing, China. Email: zhbq@cufe.edu.cn 2 Corresponding Author. PhD Candidate, School of Finance, Central University of Finance and Economics Beijing, China [Postal Address: Mengzu Village, Baishan Town, Changping District, Beijing, 102206, China] Email: davidasri@gmail.com 3 Director of the Center for Workforce Development, Associate Professor, Workforce Education and Development Program, School of Education, Southern Illinois University Carbondale, USA. Email: Ahmed.alasfour@siu.edu © Copyright: The Author(s) This is an Open Access article distributed under the terms of the Creative Commons Attribution Non-Commercial License (https://creativecommons.org/licenses/by-nc/4.0/) which permits unrestricted non-commercial use, distribution, and reproduction in any medium, provided the original work is properly cited.