Fiscal and Monetary Reaction of External Debt: Evidence from Selected South Asian Countries

Abstract

The core purpose of this paper is the computation of potential fiscal and monetary shocks linked with the external debt’s accumulation scenarios which may cause fluctuation of economic growth of selected South Asian economies through the business cycle analysis. South Asian economies have accrued a substantial amount of foreign debt which may decelerate the economic growth. To obtain the empirical evidence of these selected economies against the fiscal and monetary shocks, Structural Autoregressive SVAR is deployed. This econometric technique assists in measuring the fiscal and monetary shocks which further elucidates its impact on the economy. The Reduced-Form SVAR residuals were commuted for each selected economy to indicate the response of fiscal and monetary volatility. The results of the SVAR, Reduced-Form VAR residuals indicate that fiscal policy shocks are more responsive in designated economies South Asia as Pakistan, India, Bangladesh, and Sri Lanka, whereas monetary policy is less effective in all of these economies, both in the short and long run. As a result, greater prudence and foresight are required when developing and implementing fiscal policy. In Pakistan, India, and Sri Lanka, contractionary monetary policy is said to be sluggish and unfriendly to economic growth. Monetary policy in Bangladesh, remains lax, but an encouraging response to economic growth. However, tight monetary policy has been found to boost growth, and an interest rate puzzle has also been observed in case of Sri Lanka.