1 Debt : use it wisely

Low income countries often resort to external debt as a means to leverage growthenhancing investment. This paper investigates the dynamics of the external-debtinvestment-growth linkages across a large sample of low and middle-income economies since 1990. We adopt local projection techniques and an instrumental variable strategy to identify the dynamic impact of debt inflows on investment and growth. Our results suggest a robust role for private long-term debt inflows, relative to public debt, in stimulating domestic capital formation. We also document substantial variation across countries in the tightness of the debt-investment-growth link: observed growth returns to debt-financed investment are lower in Africa, and in countries with a lower initial stock of private and overall capital, or a higher initial public debt level. Our dynamic approach to debt sustainability, which takes into account the time path of returns to investment, can usefully complement static approaches based on statistical properties of debt and fiscal or external surpluses. JEL Codes: F34, F43, F36