The Impact of External Debt Shocks on Sustainable Economic Growth: Emphasizing Trade Openness and the Rule of Law in Developing Countries

Abstract

This study investigates the shock effects of external debt on sustainable economic growth, with particular emphasis on the roles of trade openness, institutional quality, and the rule of law in developing countries. Although external debt is recognized as an important financing instrument for compensating for domestic resource shortages and implementing development projects, its effects on sustainable economic growth are highly dependent on the institutional environment, regulatory frameworks, and economic structures of countries. In this study, panel data from ten selected countries, including Algeria, Bahrain, Egypt, Iraq, Iran, Jordan, Kuwait, Oman, Saudi Arabia, and the United Arab Emirates, covering the period from 2000 to 2024, were utilized. The sustainable economic growth index was measured based on the World Bank Sustainable Development Indicator. Explanatory variables included external debt, institutional quality, regulatory quality, the rule of law, financial development, trade openness, inflation rate, government budget deficit, and population growth rate. To analyze the short-run and long-run relationships among the variables, the Panel Vector Autoregression (PVAR) econometric approach was employed. In the first stage, the stationarity of the variables was examined using the ADF–Fisher panel unit root tests. The results indicated that all variables were stationary at level. After determining the optimal lag length, the PVAR model was estimated, and an error correction framework was employed to investigate short-run dynamics. The estimation results reveal that external debt exerts a negative and statistically significant effect on sustainable economic growth in the selected countries. In contrast, institutional quality, regulatory quality, the rule of law, financial development, and trade openness have positive and statistically significant effects on sustainable economic growth. Furthermore, inflation and government budget deficits, as sources of macroeconomic instability, impose significant negative effects on sustainable development. The error correction coefficient is negative and statistically significant, indicating the gradual adjustment of short-run disequilibria toward long-run equilibrium. Variance decomposition results further demonstrate that, over medium- and long-term horizons, shocks originating from external debt account for a substantial proportion of fluctuations in sustainable economic growth. Overall, the findings suggest that the impact of external debt on sustainable economic growth is not solely determined by the volume of debt but also depends on institutional quality, regulatory frameworks, and the degree of economic openness. Strengthening the rule of law, improving institutional and regulatory quality, promoting financial development, and adopting open trade policies can mitigate the adverse effects of external debt and facilitate the achievement of sustainable economic growth in developing countries.