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Tuffour,K., Joseph, Journal of Business Research, Vol. 6 Issues 1 & 2, 2012
73
AN ANALYSIS OF THE EFFECT OF EXTERNAL DEBT ON CROWDING-OUT OF PRIVATE
INVESTMENT IN GHANA
Joseph Kwadwo Tuffour
School of Research and Graduate Studies
University of Professional Studies, Accra
P.O. Box LG149
Accra, Ghana
E-mail: jktuffour@yahoo.co.uk
ABSTRACT
The objective of the study is to determine the effect of external debt on investment by analysing crowding-
out effect of private investment and debt overhang in Ghana over the 1970-2009 period using time series
data. Least square estimation techniques and multiple regression analysis were used. The study revealed
that debt overhang existed for the study period through its crowding-out effect on private investment. Also,
the huge debt and debt service raised future tax expectation and discouraged the private sector from
undertaking investment projects. While the accelerator effect was present, the cost of investment goods
negatively influenced private investment demand. Availability of credit seemed to have influenced the level
of investment positively. The result shows that the poor macroeconomic environment has had impact on
the desire to undertake investment activities by corporate individuals. Further analyses show that private
and public investments are highly related, as public investment significantly enhances private investment.
It is recommended that effort should be made to reduce government domestic borrowing, as that puts
pressure on interest rate. This indicates that, to achieve high economic growth and employment creation,
emphasis should be placed on improving private sector investment development, through facilitating
investment growth by using appropriate macroeconomic policies.
Key Words: External Debt Accumulation, External Debt Service, Crowding-Out, Debt Overhang, Private
Investment, Ghana
1.0 INTRODUCTION
Prior to the Structural Adjustment Programme (SAP) and Economic Recovery Programme (ERP), Ghana
government’s effort to promote private sector investment was inadequate. This was based on the socialist
ideology that the private sector was not able to push the industrialisation agenda at that time. Thus,
emphasis was placed on public sector-led growth and development. But difficulties arising from both
internal and external sources of finance led to deterioration of economic variables (Asante, 2000; Aryeetey
& Baah-Boateng, 2007). It was in line with this that the government adopted SAP/ERP in April 1983, to
reverse deteriorating economic trends.
The ERP/SAP was based on three main pillars of stabilisation, liberalisation and privatisation, of which
the first phase of stabilisation needed huge external fund inflow (Figure 1) so that the economy can be
kick-started again. GDP growth has remained positive since then. Within the programme, there were
renewed interest to put much emphasis on the private sector by establishing institutions to facilitate the
private sector development while promulgating and instituting policies such as removal of exchange rate
controls, price controls, etc. (UNCTAD, 2003). It is observed from Figure 2 that the downward trend of
private investment was reversed after 1983. On the other hand, three main issues are clear. First, there has
not been massive or accelerated private sector investment (Figure 2) while at the same time the stock of
external debt has been rising. Within this situation, the private sector has raised concerns about the
implications of the foreign debt accumulation, through debt service. With external debt problems existing,
loss of credit worthiness, higher interest rate on foreign loans, etc., the government borrows from domestic
Tuffour,K., Joseph, Journal of Business Research, Vol. 6 Issues 1 & 2, 2012
74
private market. This has the tendency to raise demand for loanable funds, increase interest rate, and so
reduce private investment.
Figure 1: Growth Rate of Ghana’s External Debt Stock
Source: Author
Figure 2: Trend of Private and Public Investment (As % of GDP)
Source: Author
Secondly, as the government maintains a higher external debt stock, there is the tendency to raise more
domestic revenue. This can be done through raising existing tax rates and/or instituting new taxes. The
expectation of future taxes and the associated discouragement effect is likely to affect private sector
investment development. Thirdly, the continual accumulation of external debt and debt service
requirement pose liquidity constraints for the government. This is reflected in the inability of government
to provide infrastructure support for the private sector. This is obvious as in developing countries; private
investment actors put much emphasis on the contribution by public sector.
The external debt situation to some extent has implications for private investment. It is noted that the level
of both public and private investment dipped again towards the year 2000 (Figure 2) which coincided with
huge external debt problems until the HIPC initiative started. Observably, after the HIPC initiative, the
trend of private investment has started to rise again. The question is: what is the link between debt
accumulation and debt service on one hand and private sector investment growth on the other? Are there
-80.00
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0.00
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0
5
10
15
20
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19701972197419761978198019821984198619881990199219941996199820002002200420062008
Private Investment (As % of GDP) Public Investment (As % of GDP)
Tuffour,K., Joseph, Journal of Business Research, Vol. 6 Issues 1 & 2, 2012
75
debt overhang and crowding-out effects? The objective of the study is to determine the effect of external
debt on investment by analysing crowding-out effect of private investment and debt overhang in Ghana.
This, therefore, forms the focus of the study. The rest of the paper is structured as follows: Section 2
presents a brief on literature review while the theoretical framework and model specification are in section
3. Section 4 contains the data analysis and results. The conclusion is contained in section 5.
2.0 REVIEW OF LITERATURE
Theories of Investment
Several theories of investment have been propounded to explain the behaviour of investment. The
neoclassical model is based on the principle of desired capital stock and user cost of capital (Jorgensen,
1963). The user cost factors may include price of a capital good that is owned and used by a firm, real
price of capital good, real interest rate and depreciation rate. The Tobin’s q model is essentially an
improvement of the initial model. Tobin (1969) introduced the ratio of the market value of a firm to the
replacement cost of its capital stock - a ratio called “q” - to measure the incentive to invest in capital.
Tobin’s q, as it has become known, is the empirical implementation of the notion that capital investment
becomes more attractive as the value of capital increases relative to the cost of acquiring the capital. Tobin
(1969) was of the view that share prices can be thought off as market’s best estimate of the value of present
and future profits, so they capture future expectations. Thus, the rate of investment is related to q. In
addition, q should take account of uncertainty, growth in future demand, taxes, etc. This model has
relevance for the current market as the share price of a firm directly and indirectly indicates the value of
an existing capital investment for that firm.
The basic accelerator model is built around output in an economy. In this model, investment is determined
to be a linear proportion of the changes in total output. This ignores other variables such as level of
profitability of the investment, investor expectations and cost of capital. The theory proposes that there is
a fixed level of output that translates into investment. At the same time, the level of targeted output can be
determined when the incremental capital-output ratio is known. This model’s assumptions pose some
problems such as fixed desired capital stock to output ratio and the fact that desired and actual capital
stocks are the same when there is adequate investment. These problems led to the flexible accelerator
model, a modification of the basic model. The new model considers the difference between the desired
and actual/existing capital stock, as investment responds to this difference. Thus, new investment would
depend on the adjustment factor, which shows how fast or slow investors prefer to invest in each period.
The Mckinnon (1973) and Shaw (1973) model emphasizes a more liberal approach to investment. Their
model considers financial issues in developing countries where there is financial repression. These include
interest rate controls and other limitations of the financial sector. It was anticipated that, if these controls
are removed, savings, loanable funds, investment, employment and output would improve. Pindyck (1991)
and Rodrik (1991) have proposed uncertainty investment theories. Pindyck’s uncertainty was about
irreversibility of investment. This is because capital goods of firms are usually firm specific and, thus,
disinvestment is difficult. Rodrik (1991) on the other hand introduced policy uncertainty. Investors do not
respond fully to new policy introduction. This is because any new policy introduced about investment is
taken with caution. Such uncertainty includes the possibility of reversing to the old policy or conditions
when economic expectations are not met. Political support for the new policy may be short lived or the
policy may rather worsen private sector’s investment decision.
Tuffour,K., Joseph, Journal of Business Research, Vol. 6 Issues 1 & 2, 2012
76
Empirical Review of External Debt and Investment Linkage
The impact of external debt on output has been theorised through its impact on investment. This overhang
effect, caused by crowding-out of debt on investment and other indirect constraints, has been hypothesized
to be negatively related to private and public investment (Sachs, 1989; Krugman, 1988). Other studies
have confirmed the crowding-out and overhang effects, such as Iyoha (1999), Anyanwu and Erhijakpor
(2005) and Ayadi and Ayadi (2008) for groups of countries.
A high debt service will minimise available foreign exports earnings to stimulate public investment. When
debt and debt-servicing of a country increase, private investment falls as investors are discouraged because
of the expectation that future corporate taxes would increase to pay off the outstanding debt. Also, when
government resorts to domestic borrowing, interest rate rises and investment falls. Thus, the study would
consider whether this effect occurs in Ghana, given the existing data.
A study on Argentina by Morisset (1991) investigated direct and indirect interactions among external debt,
investment and economic growth. Morisset estimated a 3SLS with simulation analysis. The drastic
reduction in private domestic investment was argued to have resulted from credit rationing. This reduced
the production capacity as investment falls. In addition to this domestic disincentive effect, there is also
expectation of high taxes by foreign investors. These combine to reduce the incentive to invest.
In their contribution to the debt literature, Abbas and Christensen (2010) showed that, in a panel of low-
income countries and emerging markets, at moderate levels, domestic debt has a positive contribution to
GDP growth. However, as long as the stock of domestic debt becomes large (above 35 percent), its
contribution to economic growth turns negative, due to inflationary pressures and the crowding-out of
private investment.
Safdari and Mehrizi (2011) research showed that external debt had a negative effect on gross domestic
product and private investment in Iran for the 1974 – 2007 periods. It was noted that public investment had
a positive relation with private investment. Michael et al. (2010) maintained that greater ratios of foreign
debt to total debt are associated with increased risks of currency and debt crises, although the strength of
the association depends crucially on the size of a country’s reserve base and its policy credibility. In
addition, they were of the view that financial crisis, driven by exposure to foreign currency, resulted in
significant permanent output losses for the 45 countries studied.
Caner et al. (2010) estimate a public debt threshold at 77% of GDP. The indicative non-linear effect of
debt on economic growth means that, for moderate debt levels, an increase in the public debt–GDP ratio
helps in expanding public investment, which translates into growth. But above the threshold level, any
additional debt acquired reduces output growth (Abbas & Christensen, 2010; Presbitero, 2010). The
literature review together with the theories of investment serves as the basis to develop an appropriate
investment model for Ghana.
3.0 METHODOLOGY
Investment Model
Following literature review on one hand and background of the study area on the other, a private
investment demand function is specified. Also, an allowance is made for the potential existence of
crowding-out and overhang effects of external debt as well as the investment accelerator effect, policy and
institutional uncertainties. The private investment model to be estimated takes the form:
*
0 1 2t t t t
PI D Z
... (1)
Tuffour,K., Joseph, Journal of Business Research, Vol. 6 Issues 1 & 2, 2012
77
where PI is private investment to GDP ratio and
i
are the coefficients to be estimated. Zt is the set of
explanatory variables that have been shown to be empirically robust in determining investment, D*t is the
set of external debt related variables and ε is the error term which is assumed to be iid (0, σ2). In order to
estimate the effect of external debt, different models are estimated based on different theoretical
underpinnings. D*t variables include D, the ratio of external debt to output, expected to measure overhang
hypothesis and DSX is the ratio of debt service to exports, expected to capture the crowding-out effect.
The related Zt variables include:
y
the real GDP growth, to reflect the ‘investment accelerator effect’
and market potential, E is the rate of exchange (defined to reflect the fact that, an increase in E represents
a depreciation), Int is commercial interest rate (lending rate), Pui is public investment as a percentage of
GDP, OP is openness (trade intensity) defined as the sum of export and imports to GDP ratio, to capture
the external sector and lag of PI is to capture investment climate.
In the specification, private investment growth depends negatively on domestic interest rate, negatively on
external debt to GDP ratio, negatively on debt service to export ratio, positively on output and investment
climate. The state of institutions and level of exchange rate effect is not determined a priori, but each could
be positive or negative on investment. When there is accelerated economic growth, capital inflow in the
form of foreign direct investment (FDI) would also improve as well as existing capital (investment). The
increased economic growth will further enhance investment. Thus, economic growth and investment are
positively related.
Exchange rate may or may not positively relate to private investment growth. This is on the grounds that
the aim of investors may not be outward orientation. In the case of high domestic demand and the case
where FDI comes to take advantage of available domestic market, exchange rate may not influence exports
to grow. On the contrary, exchange rate depreciation is expected to boost exports. This inherently
encourages investors to produce goods to take advantage of the huge world market.
Financing domestic investment attracts a cost, particularly if funds are borrowed from the commercial
financial institutions. When there is a relatively lower interest rates on loans, investors can borrow more
and capital stock can increase to enhance output. On the contrary, where there is a relatively higher interest
rate, investors would be discouraged to invest. Debt-service is expected to have a negative effect on
investment. This may occur when, due to debt service, government resorts to domestic borrowing which
pushes up interest rate. Also, related to this crowding out is that debt would make existing capital in a
debt-ridden country to fly out – capital flight. Foreign and domestic private investment falls as well.
The level of investment climate influences the rate at which investment decisions are taken. A favourable
investment climate, presented by existence of functional property rights, rule of law, investment policy,
etc., enhances private sector investment decision. The governance variable, PD, is expected to be either
positively or negatively related to investment growth. Democratic governance serves as a probable good
atmosphere for investment to take place as investors’ confidence is enhanced. On the other hand, military
rules, particularly the type experienced in Ghana before 1992, deter meaningful economic activity. In this
respect, it is expected that democratic institutions would facilitate investment, particularly as that has
existed since 1992 in Ghana. Thus, PD is expected to be either positive or negative.
Estimation Technique and Unit Roots Tests
The essence of regression analysis is to estimate both short and/or long term economic relationships. But
recent developments in econometrics reveal the need to ascertain the stationarity of time series properties.
This is usually the case when the units of measurements of the variables are in levels. On the contrary, the
independent and dependent variables used in the models are weighted by GDP to obtain ratios, while other
Tuffour,K., Joseph, Journal of Business Research, Vol. 6 Issues 1 & 2, 2012
78
variables are in growth rates. As in many cases, trends are removed by working with ratios and growth
rates.
In addition to the above, the stationarity of the variables in the models was confirmed. The tests were done
using two recent improvements in the unit roots tests: the Ng-Perron and Dickey Fuller-Generalised Least
Square (DF-GLS) tests. The ADF and PP unit root tests are known to suffer potentially severe finite sample
power and size problems. A variety of alternative procedures have been proposed that try to resolve these
problems, including Ng and Perron, and Elliott, Rothenberg, and Stock DF-GLS tests (Wickremasinghe,
2004).The results of these tests are presented in Table 1 below, showing that the variables are stationary.
Along the lines of ADF unit root test, a more powerful variant is the DF-GLS unit root test proposed by
Elliott, Rothenberg and Stock (ERS, 1996). These results (Table 1) show all the variables are stationary at
conventional significant levels.
Table 1: Dickey Fuller-Generalised Least Square and Ng-Perron Unit Root Test Results
Variables
GF-GLS Unit Root Test
Ng-Perron Test
Critical values
DF-GLS Statistic
1%
5%
10%
Comment
MZt Statistic
Comment
Y
-3.65
-2.65
-1.94
-1.61
I(0)***
-2.69
I(0)***
PI
-1.92
-2.65
-1.94
-1.61
I(0)*
-1.99
I(0)**
D
-1.97
-2.65
-1.94
-1.61
I(0)**
-1.99
I(0)**
DSX
-1.98
-2.65
-1.94
-1.61
I(0)**
-1.99
I(0)**
E
-1.7
-2.65
-1.94
-1.61
I(0)*
-1.70
I(0)*
Int
-1.63
-2.65
-1.94
-1.61
I(0)*
-1.87
I(0)*
PUI
-1.67
-2.65
-1.94
-1.61
I(0)*
-1.74
I(0)*
OP
-1.98
-2.65
-1.94
-1.61
I(0)**
-1.78
I(0)*
DC
-2.30
-2.65
-1.94
-1.61
I(0)**
-2.1
I(0)**
CT
-1.62
-2.65
-1.94
-1.61
I(0)*
-1.99
I(0)**
CPI
-2.12
-2.65
-1.94
-1.61
I(0)**
-1.88
I(0)*
Note: The Asymptotic critical values for Ng-Perron unit root test for 1%, 5% and 10% are -2.580, -1.980
and -1.62 respectively. *** Significant at the 0.01 level; ** Significant at the 0.05 level; * Significant at
the 0.1 level, MZt is the modified transformation of the t-statistic of the Ng-Perron test. MZt is used since
MZt = MZa * MSB. Lag length: (Spectral GLS-detrenched AR based on SIC, Maxlag = 9); with a
constant. To cross check the state of unit root, the Ng-Perron unit root test results also show the variables
are stationary. In this case, and given the above mentioned conditions, the model is estimated.
3.0 RESULTS AND DISCUSSION OF THE INVESTMENT MODEL
Using annual series from 1970 through 2009 for Ghana and Least Squares estimation method, the model
is estimated below. In order to determine the existence of debt overhang, crowding-out and accelerator
effects among others, on private investment, a number of models were built around the theories of
investment. Table 2 presents the results of four of such theories. Each of the equations (A to D) is in turn
explained, followed by general inferences from these equations in respect of the issues under
consideration.
Tuffour,K., Joseph, Journal of Business Research, Vol. 6 Issues 1 & 2, 2012
79
Table 2: Results of Private Investment Models
Coefficients of Private Investment Specifications (Equations)
A
B
C
D
Variables
Effect of External
Debt (Under
Keynesian
Conditions)
Effect of External
Debt (Under
Neoliberal
Conditions)
Effect of External
Debt (Under
Uncertainty
Conditions)
Effect of
External Debt
(Under
Neoclassical
Conditions)
Const
5.78 (3.44)***
5.52 (3.06)***
6.0 (3.3)***
4.44 (1.92)*
D
-0.057 (-1.88)*
-0.12 (-3.87)***
-0.07 (-1.85)*
-0.09 (-3.3)***
DSX
-0.019 (-0.57)
-0.026 (0.84)
-0.013 (-0.5)
-0.03 (-1.3)
OP
0.069 (1.64)*
0.04 (1.3)
DC
0.133 (0.54)
0.23 (1.82)*
0.05 (0.63)
CT
0.34 (0.39)
E
0.60 (5.2)***
0.16 (3.5)***
0.17 (3.7)***
Int
-0.15 (-1.80)*
-0.08 (-0.89)
-0.19 (-2.2)**
y
0.19 (1.74)*
0.06 (0.57)
0.14 (1.67)*
Pui
0.55 (3.7)***
Pi (-1)
0.30 (1.85)*
CPI
0.06 (3.21)***
Adjusted R2
0.71
0.74
0.73
0.85
F-Statistics
13.30
19.65
18.51
19.7
Note: Values in brackets are the t-statistics. *** Significant at the 1% level; ** Significant at the 5% level;
* Significant at the 10% level; DSX - debt service to exports (calculated from World Development
Indicators, 2010); CT - company tax as percentage of GDP (Owusu-Afriyie, 2009, Bank of Ghana); CPI
- CPI (2005 = 100) (Source World Development Indicators, 2010); the other variables are as explained
earlier.
The Keynesian private investment model may comprise the accelerator and flexible accelerator concept.
In this model, the emphasis is placed on the impact of GDP growth and internal funds such as credit to the
private sector. It is observed from equation A in Table 2 that the accelerator effect applies in Ghana as the
coefficient is positive and also significant at 10%. This means that output has significant implications for
private investment. A proxy for price of output, CPI is also positive and significant at 1% as expected,
indicating that investors respond to output price. In the same way, a control variable –trade intensity –
shows positive and significant contribution to private investment growth. Domestic credit is positive but
not significant in explaining private investment growth.
The external debt variable shows a significant negative effect while debt-service was not significant. The
implications of the effects of the debt variables are that investors put much emphasis on the
discouragement effect of debt accumulation but debt service induced crowding-out effect applies
marginally. Thus, within the Keynesian-accelerator model (equation A of Table 2), the debt overhang has
stronger existence than the crowding-out effect.
In the framework of the Neoliberal (McKinnon-Shaw) – equation B – of Table 2, the ‘conduit effect’ does
not apply. The coefficient of interest rate was rather negative. This shows that the proposal to actually
liberalise the interest rate for the rate to go higher so that availability of loanable funds would increase (as
deposit increase) for investors to borrow, does not hold. This notwithstanding, the level of domestic credit
Tuffour,K., Joseph, Journal of Business Research, Vol. 6 Issues 1 & 2, 2012
80
enhances private investment as it is significant at 10% level. In the same way as the Keynesian model, the
debt overhang is observed but does not seem to go through the crowding-out effect alone. The coefficient
of debt is negative as expected and highly significant (1%) while debt service is not significant. This
confirms the fact that in the past Ghana government has not borrowed much from the private domestic
financial institutions. Thus, private investment is influenced through expectations of future higher taxes
and associated investor discouragement.
Equation C shows the impact of external debt under uncertainty propositions. In this case, related policies
are examined. The proxy for investment climate shows a significant positive effect on private investment
growth. Thus, given any favourable investment in the previous period, private investment is likely to
respond positively in the current period, all things being equal.
In addition to the investment climate, interest rate seems to show the normal negative impact on private
investment. This contradicts the idea that the interest rate should be allowed to be determined by the market
as in the McKinnon-Shaw proposition, where it is argued that higher interest rate leads to higher savings
and consequently higher private investment.
Another investment related variable – exchange rate – seems to be one of the most important variables
under the uncertainty model. The coefficient is positive and highly significant (1%). With the liberalization
policy, a depreciation of the exchange rate encourages exports. This indicates that private investors
respond greatly to exchange rate movements. Thus, private investors seem to be less uncertain with
exchange rate than with interest rate.
The study revealed that both the debt overhang and crowding out effects occur under the policy uncertainty
scenario. The negative coefficient (-0.07) and the significance (at 10%) of the debt level reveal the non-
linear effect of external debt accumulation on GDP in the long run. While the debt service variable was
negative, it was not significant, also confirming that domestic borrowing by government has not exerted
much on private investment to reduce GPD greatly. Rather, private investors may have been considering
the policy environment of future taxes or they were not getting infrastructural support from government
since the government suffers from liquidity constraints as a result of debt service.
Equation D is based on the neoclassical model of investment which emphasizes the roles of interest rate,
tax structure, public investment among others. Within this framework, it is noted that the external debt
overhang strongly exists. The coefficient is negative (-0.09) and highly significant (at 1%). On the other
hand, the crowding-out variable is not significant. This confirms earlier outcomes. Within this model, the
variables that can be linked to policy and Keynesian propositions are correctly signed and also significant.
For instance, public investment and exchange rate enhance private investment growth. The variables are
positive and highly significant at 1%. Interest rate, as expected, is negative and significant at 5% level.
This confirms the neoclassical view. Again, the accelerator effect is confirmed as in equation A. Other
variables of interest such as corporate tax structure and domestic credit which are important in determining
private investment are each positive as expected, although they are not significant.
Crowding Out Effect
One of the objectives of this study is to determine the extent of crowding-out effect of external debt
accumulation. This is examined from the perspective of various specifications (see the row of DSX in
Table 2). In relation to the effect of external debt service on private investment, it was found that there is
a negative relation between the two variables as evidenced by Asante (2000), Krugman (1988), Iyoha
(199) and Anyanwu and Erhijakpor (2005). This means that high foreign debt servicing has led to marginal
increased usage of domestic borrowing by government. This raises domestic interest rate (lending rate),
Tuffour,K., Joseph, Journal of Business Research, Vol. 6 Issues 1 & 2, 2012
81
thereby, constraining the ability of private domestic borrowing, as demand for loanable funds increases.
The increased interest rate increases the cost of borrowing and hence reduces private investment.
Generally, the results revealed that external debt service crowded out investment formation in the country
over the study period. The crowding-out effect does not seem strong enough in Ghana though.
Debt Overhang
The debt overhang variable is expected to be negative and significant. For the various investment models,
foreign debt negatively influences private investment formation for the study period. Similar results were
obtained by Iyoha (1999), Fosu (1996) for South Saharan African countries including Ghana, and for
Zimbabwe by Jenkins (1998) and Tuffour (2012) for Ghana. This might be due to the potential of
government’s inability to implement private sector infrastructure support projects. Alternatively, the
inability of government to provide such facilities increases private sector operating costs. This indicates
that high external debt servicing reduces available exports earnings to undertake infrastructure projects
which have great impact on economic growth. In addition to the liquidity constraint, the huge debt and
debt service reduce investor confidence through expectation of higher taxes.
Accelerator Effect
The “accelerator effect” exists in the investment model as was identified by Asante (2000). A number of
reasons may present this situation. Firstly, there may be quite high adjustment toward desired capital stock.
Secondly, output growth may be offering strong confidence to the private sector. Thirdly, it is observed
that the growth trend of GDP since 1985 (constituting most part of the study) have ranged from 3.3% to
7.3% (an average of 4.8% over 25 years). This trend has strong basis to pull private investment along.
Fourthly, increases in growth caused by improvement in aggregate demand may also have energised
private investment.
Discussion of Other Variables
There is a negative effect of domestic interest rate on private investment. The significant impact
collaborates that of debt service. The idea behind this phenomenon is that the private sector put much
emphasis on the level of interest rate in undertaking investment decisions. Thus, government’s demand
for capital from the private financial institutions puts upward pressure on the domestic lending rate. This
is on the background that the interest rate over the years has been relatively high compared to other
developed countries. Previous private investment level has significant positive impact on current private
investment. The impact of the exchange rate was found to be highly significant in improving private
investment. The main reason for this arises from the exports of goods and services, through various
initiatives by government, such as the Ghana Exports Promotion Council. This is evident in the rise of
non-traditional exports by 56% from 2005 to 2009.
The analyses show that there is a positive effect of public investment on private investment (see equation
D of Table 2). This is clear from the inherent potential contribution of public investment in areas such as
infrastructure provision. The existence of these facilities reduces the associated cost to the private sector
in taking investment activities. The availability of domestic credit positively contributes to investment.
This confirms earlier studies for Ghana (Asante, 2000). In the same way, trade intensity seems to contribute
to private investment decision-making. In accordance with the rationale that increased aggregate demand
would facilitate investment formation, the output price index shows this scenario. Also, this implicitly
supports the q-theory of investment where the increased value of existing capital leads to more investment.
Tuffour,K., Joseph, Journal of Business Research, Vol. 6 Issues 1 & 2, 2012
82
4.0 CONCLUSION
The main objective of this study is to estimate the long run impact of foreign debt on investment in Ghana
for the period 1970 - 2009. In specific terms, the study examined the existence of debt overhang and
crowding-out of investment through external debt service. The investment model shows that the influence
of public external loans, in the long run leads to crowding-out of investment and debt overhang on output.
This occurs in two ways. First, through debt servicing: This foreign exchange constraint reduces available
foreign exchange requirement for public investment in infrastructure that supports private investment.
Second, through government borrows: When government borrows from the private financial market,
interest rate rises and private investment falls. Domestic private investment is also constrained at the end
through expectation of higher tax conditions. The combined effects of these scenarios support the existence
of debt overhang.
The study found that both accelerator effect and investment climate enhance private investment. Further
analyses show that both private and public investments are highly related and public investment
significantly enhances private investment. This is obvious, because in developing countries private
investment actors put much emphasis on the contribution by public sector in terms of infrastructural
support. This indicates that, to achieve high growth and employment creation, emphasis should be placed
on improving private sector investment development through facilitating their growth by using appropriate
macroeconomic policies.
Tuffour,K., Joseph, Journal of Business Research, Vol. 6 Issues 1 & 2, 2012
83
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