Unraveling the social development impact of internal and external debt in highly indebted countries

Purpose Increased reliance on debts can have an overhang effect, which may hinder the pro-poor efforts and form multiple financial constraints. This study estimates the social debt carrying capacity while allowing potential transition between internal and external debt in highly indebted countries. Design/methodology/approach The dynamic assessment included 68 countries between 1960 and 2023 using a two-step Panel ARDL model with a quadratic transformation of internal and external debt. Findings The results from robust modeling showed that disaggregated debt has a U-shaped effect on poverty, advocating the presence of the Debt Laffer Curve effect. The indebted countries are not able to alleviate poverty through their labor resources and need increased physical capital and trade openness to break the poverty trap. Research limitations/implications The study focuses specifically on highly indebted countries, and the findings may not be generalizable to countries with different debt profiles or economic structures. Practical implications The results provide valuable insights for policymakers in formulating effective debt management strategies, particularly highlighting the importance of considering debt composition when designing policies for social development. Moreover, prioritizing domestic borrowing and debt ceilings can mitigate poverty. Originality/value This research contributes to the debt literature by differentiating between internal and external debt effects on poverty, addressing a gap in previous Debt Laffer curve studies that often treat debt as a homogeneous concept. Prior studies treat debt homogeneously; this paper differentiates between internal and external debt effects.