Examining the enhancers and reducers of external debt servicing capacity: evidence from Sierra Leone

The use of external debt to address budgetary needs has become critically topical among economists and policymakers, especially in developing economies. With the evolving global economic landscape, state expenditures often exceed tax revenue in many countries, leading to increased external borrowing (Dubbert, 2024). According to the United Nations Conference on Trade and Development [UNCTAD] (2024), global public debt has increased by more than fivefold since 2000, outpacing global GDP, which has tripled over the same period. In emerging and middle-income economies, the proportion of debt to GDP is expected to reach 80% by 2028 (Tobias et al., 2024). Consequently, global institutions like UNCTAD (2024), IMF (2023) and the World Bank (2023) have expressed significant concerns about the sustainability of these loans, which refers to the ability of an indebted country to meet all its current and future repayment obligations without significant financial support or risk of default (IMF, 2023; Hakura, 2020). Holland and Pazarbasioglu (2024) reported that debt servicing costs are increasing rapidly and are now at worrying levels, especially for low-income countries. They argued that the external debt service (EDS)-to-revenue ratio (EDSR) has generally increased by two-and-a-half-fold from a decade earlier. In some low-income countries, this metric has risen from 6% to almost 14% and up to 25% in some typically low-income countries over the past decade. The concern of debt servicing capacity in developing countries is also highlighted in recent debt sustainability studies such as Dubbert (2024), Uxó et al. (2024), Owusu et al. (2023) and Klutse et al. (2023), attributing these vulnerabilities to adverse economic shocks and some ineffective structural changes. Hence, it is critical to analyze debt sustainability to allow indebted countries to anticipate future risks and modify their financing terms. This is an important aspect in a country’s fiscal management as default will adversely affect growth and investment and subject the country to high borrowing costs (World Bank, 2024; IMF, 2023).

External debt servicing continues to make headlines in public finance and fiscal management. Despite its growing discourse, much of the literature on external debt servicing capacity looks more at its severity (Tobias et al., 2024; Arodoye, 2024), trends (Dubbert, 2024; Bentour, 2022) and its link with structural reforms (Uxó et al., 2024; Afonso and Ibraimo, 2020). We depart from recent external debt studies, such as Okutimiren et al. (2024), Edo and Oigiangbe (2024), and Azolibe (2022) by examining the relationship between a country’s capacity to service its external debt and changes in key market variables. A close examination of this nexus will offer a better understanding of how changes in key macroeconomic variables would impact debt sustainability. It will highlight the enhancers and reducers of a country’s external debt servicing capacity, especially for developing countries. Sierra Leone, a heavily externally indebted nation, presents a fascinating case study. Sierra Leone’s high risk of debt distress is noted by the IMF, and the country is still grappling with fundamental economic challenges (IMF, 2020). With a weak fiscal space, the country still relies on external debt to finance diverse budgetary items. Additionally, Sierra Leone’s economy has experienced a staggering cyclical pattern, especially in the last 10 or more years, swinging from the state of being one of the fastest-growing economies in the world in 2013 to a recession in 2015 (IMF, 2020, Statistics Sierra Leone [SSL] 2014). The country is then struggling to cope with the economic challenges precipitated by the coronavirus disease 2019 (COVID-19) pandemic (IMF, 2024). Given this economic background, it is critical to examine both the positive and negative effects of changes in key economic variables on the country’s capacity to service its external debt. We use a non-linear ARDL to unbundle these effects and record the following contributions to the literature on external debt.

Measured by the ratio of debt service on external debt to revenue, this study is the first that integrate the asymmetric effects of market fundamentals on the country’s capacity to finance its external debt. Previous studies used the debt-GDP ratio, and they also assumed symmetric effects with economic variables. Due to ongoing changes in a country’s macroeconomic environment, combined with the vicissitudes of global market trends, the assumption of symmetric effects may lack precision in terms of impact. Our study examines how positive and negative changes in key market variables would impact the capacity of an indebted country to meet its loan obligations. This approach sheds more light on the ramifications of the continued changes in market fundamentals on external debt management. These results have practical implications for fiscal policymakers, especially in the realm of external debt management.

Second, we identified the key drivers of the external debt servicing capacity of a developing country. We found real GDP growth to be a critical enhancer of the country’s capacity to service its external debt. Both short-run and long-run results reveal that growth in the productive sectors would greatly boost the capacity of country to meet its debt obligations. More importantly, the decline in exports and foreign direct investment (FDI) is reducer of the country’s capacity to finance its external debt, causing devastating effects on its ability to service its loans. These results show the importance of adopting an export drive and boosting FDI to enhance the capacity of a country to meet its loan commitments. These findings could inform policymakers in formulating sound and more prudent fiscal policies that are geared toward minimizing the high levels of indebtedness, especially in developing countries. The results could inform fiscal policymakers about the importance of channeling debts to more productive sectors of the economy to enhance growth and ease the burden of external debt.

Finally, by examining the asymmetric effects of market fundamentals on a country’s external debt servicing capacity, we have provided a more robust analysis and a novel approach to the literature on external debt management. The use of the NARDL model, combined with various diagnostic tests, allows us to identify the enhancers and reducers of a country’s capacity to service its external debt. These taxonomies of macroeconomic variables have offered a more detailed inquiry into a country’s capacity to meet its debt obligations.

The rest of the paper is organized as follows: Section 2 provides Sierra Leone’s macroeconomic outlook, while Section 3 presents the literature review. Section 4 contains the data and methodology. Section 5 presents the results, while Section 6 presents the concluding remarks.

This section encapsulates stylized facts on Sierra Leone’s debt profile from 2000 to 2024. This represents the period from the IMF and World Bank Heavily Indebted Poor Countries [HIPC] initiative, through the Ebola outbreak, to the COVID-19 pandemic and post-pandemic. Before the execution of the HIPC initiative, Sierra Leone’s public and publicly guaranteed external debt in nominal terms was estimated at US$1.2bn in December 2000 (IMF, 2002). To qualify for the HIPC initiative, Sierra Leone prepared and implemented an interim and a final Sierra Leone Poverty Reduction Strategy Paper [PRSP](2005). This activates some structural reforms that include the establishment of the National Revenue Authority (established from two antecedent institutions: the Customs and Excise Department, and the Income Tax Department), the National Social Security and Insurance Trust, the National Commission for Social Action, the Anti-Corruption Commission, and a decentralization policy framework. These structural reforms served as important pillars for achieving the desired results of the HIPC initiative (Hussain and Gunter, 2005).

According to the Africa Development Bank Group [AfDBG] (2007), with the IMF and World Bank’s approval, Sierra Leone received HIPC assistance of US$ 675.2m in 2000 disaggregated as follows: US$ 340.1m from multilateral debt relief; and US$ 335.1m from bilateral and commercial, representing 50.4 and 49.6% of the total debt relief respectively. Sierra Leone further qualified for the enhanced HIPC initiative under the Multilateral Debt Relief Initiative (MDRI) in 2006, receiving additional debt service savings on debt owed to the International Development Association [IDA], the IMF and the African Development Fund [ADF] of about US$ 556.2m. As noted in the Sierra Leone PRSP II in 2008, the debt relief by both multilateral and bilateral creditors significantly reduced the debt stock of Sierra Leone from US$1.7bn in 2006 to US$580.1m by June 2008. This is supported by Djimeu (2018), who reported that the HIPC initiative has a greater impact in countries with limited access to international capital markets. These programs boost private investment in most Sub-Saharan African countries during the post-completion period but have limited effects on FDI or economic growth. Henri (2019) shared a similar sentiment by expressing the lack of a significant effect of short-run debt relief on GDP per capita growth.

Further, despite the debt relief, Sierra Leone’s macroeconomic situation was still fraught with significant challenges. Public debt has continued to increase since the country benefited from external debt cancellation after reaching the HIPC completion point in 2006 (Ministry of Finance, Sierra Leone [MoFSL] 2023). Primarily, as documented in Sierra Leone’s development plan for 2013–2018, the Agenda for Prosperity, the improvement in domestic revenue mobilization was not commensurate with public expenses. This causes huge budget deficits, resulting in further external borrowing to finance various development projects in the country. Consequently, the total external debt stock of the country increased from US$1,624.70 million in 2016 to US$1,794.50 million in 2017, US$1,833.50 million in 2018 and US$1,930.10 million in 2019 (World Bank, 2024). Despite the unprecedented economic growth of 20.14% in 2013 (Statistics Sierra Leone [SSL] 2014), the twin shocks emanating from the significant decline in the global prices of iron ore in late 2013 and the Ebola virus disease outbreak in the country in 2014 landed the country in a recession in 2015. The COVID-19 pandemic exacerbated the economic outlook of the country for 2020 and beyond. The significant drop in FDI inflows and the decline in tourism revenue due to a drop in international tourist arrivals following international travel restrictions also hurt the country’s economy (AfDBG, 2020; World Bank, 2020). Again, this induced the use of loans to finance the government budget, further raising the country’s debt stock as reported in Table 1.

From Table 1, multilateral institutions, especially the World Bank and IMF, remain the biggest creditors of Sierra Leone, accounting for at least 79% of the country’s total external debt over 2020 and 2023. This raises some debt sustainability concerns, as reported in the IMF’s projection of key sustainability indices in Table 2. For instance, the EDSR is expected to track upward until 2026 and slightly slow down towards 2030. The ratio is consistently above 50%, indicating the high proportion of government revenue that will be used in debt service. This raises significant challenges in sustaining these loans, potentially creating more macroeconomic woes for the country.

The section covers the debt sustainability framework and the relevant literature review on external debt, including debt sustainability and the determinants of debt servicing.

The study is theoretically underpinned by the IMF-World Bank Debt Sustainability Framework [DSF] for low-income countries. This framework dovetails the lender and borrower considerations to guide the borrowing decisions of low-income countries in a way that matches their financing needs with their capacity to repay the loan (IMF, 2024). The DSF links economic variables with debt sustainability to offer a bigger picture of the debt situation of a country (Were and Mollel, 2020). As shown in Section 2.0, Sierra Leone has maintained a long-standing relationship with both the World Bank and the IMF, and the DSF has been applied in analyzing the debt profile of the country. Premised on this background, we adopt a three-component theoretical framework as groundwork for evaluating the sustainability of external debt in Sierra Leone. These three elements are: (1) the broad macroeconomic landscape of Sierra Leone, (2) the country’s external debt providers, and (3) the evaluation of the country’s capacity to service debt using key sustainability indices. This geometry of external debt sustainability illustrates a proactive application of the DSF principles, showcasing a forward-thinking approach to tackling fiscal challenges. The framework is depicted in Figure 1.

From Figure 1, we situate the external debt lending landscape in our study by examining three important components from the borrower and the lender perspectives. This drives decisions around external borrowing. For instance, the borrowing country examines its current and evolving macroeconomic environment, paying attention to key economic variables like real GDP growth, exchange rate fluctuations, budgetary needs and external trade to determine its borrowing capacity. In Nigeria, for instance, the use of external debt is rooted in insufficient tax revenue and the need to address inadequate foreign exchange earnings (Okutimiren et al., 2024). This means circumstances of failed market fundamentals could trigger external borrowing in most developing countries (Okutimiren et al., 2024; Dinga and Fonchamnyo, 2021). This makes external debt an integral part of the entire economic or financial system of a country (Petrushenko et al., 2022). As such, blending the economic outlook of a country with its external debt sustainability metrics, such as the external debt-to-GDP ratio and the external debt-to ratio, is critical in assessing the external borrowing capacity of the country. This nexus sets the tone for negotiations between the borrowing nation and the lending institution to inform decisions around the loan covenant. For instance, as reported by Azolibe (2022) and earlier by Oyedele et al. (2013), the weak fiscal space in the Sub-Saharan African region leads to external debt accumulation with possibly high interest rates. The loan providers in Sierra Leone are predominantly multilateral and bilateral institutions, as well as local commercial banks and bondholders. The interface between these lending institutions and the country is done within the parameters of broad macroeconomic performance and debt sustainability concerns. The theoretical framework is therefore a synthesis of the state of key economic parameters, the benchmarks for evaluating external debt sustainability and the lending criteria of the loan providers.

Two strands of the literature on external debt are reviewed – the use of external debt and its sustainability, and the determinants of external debt.

The use of external debt is a common practice in the realm of fiscal management in both developing and developed countries. Findings on the benefits of this financing strategy are somewhat mixed (Makun, 2021). Studies such as Onafowora and Owoye (2017), Edo et al. (2020), Oronde et al. (2020), Jung and Zhang (2021), and Khan et al. (2021) argued that external debt, if directed towards the productive sectors of the economy, will enhance economic growth. Conversely, Kharusi and Mbah (2018), Hakimi et al. (2019), Dey and Tareque (2020), Moroz (2021), Biswajit (2021), and Edo and Oigiangbe (2024), each reported the negative effect of external debt on investment, economic growth and other macroeconomic variables. Either way, the level of indebtedness, especially in low-income countries, has raised serious concerns about the repayment obligations of these countries (IMF, 2023; World Bank, 2023). More stakeholders in the economic management of developing countries have expressed significant concerns about the inadequate foreign reserves to service external debt (Edo and Oigiangbe, 2024). There is now an increasing focus on the assessment of the capacity of these indebted countries to sustainably manage their loans.

The recent study by Vaggi and Frigerio (2024) reiterated the worrying signs of the rapidly increasing indebtedness among African countries. A few years ago, Shittu et al. (2020) found that only five countries in Sub-Saharan Africa – Malawi, Uganda, Nigeria, Kenya and South Africa – accounted for 47% of the external debt of the 46 countries in the region. The external debt stock is more likely to increase in developing countries during a recession due to shrinking GDP (Bentour, 2022). Therefore, heavily indebted Sub-Saharan African countries will allocate a significant proportion of their public funds to EDS, narrowing their budget for development projects (Vaggi and Frigerio, 2024). Such high levels of external debt servicing, especially in developing countries, will harm GDP growth and investment (Akram, 2017). Bradlow et al. (2024) also noted that a country’s inability to sustainably manage its debt can adversely affect its economic growth and its capacity to invest in essential services and infrastructure. In Mozambique, for instance, Afonso and Ibraimo (2020) found a detrimental effect of debt service on real output, inflation and domestic currency depreciation. As such, for debt service to be sustainable, the debt threshold should be lower for developing countries than for advanced economies (Duygu, 2018). Arodoye (2024) recommended that Sub-Saharan African countries experiencing extremely high external indebtedness should adopt reliable and dependable debt service strategies to reduce the deleterious effects of debt on economic growth. Along this line, Cormier (2021) suggested the adoption of an independent debt management system that would enhance debt sustainability. Ohiomu (2020) espoused the implementation of stricter debt management systems that seek to reduce debt burdens and foster investment drives that would stimulate economic growth and sustainable development.

The literature on the economic and financial determinants of the capacity of developing countries to meet their debt obligations has evolved significantly. Understanding these influences, particularly about external debt servicing capacity, is critical to informing decision-making on lending, debt management and economic policy formulation (Saliya, 2023). Summarily, the key determinants of a country’s debt servicing include the real GDP growth, value of exports, government spending, exchange rate, FDI, domestic savings and the tax base (Jonasson et al., 2024; Baniata et al., 2023; Alvarado et al., 2017).

The real GDP growth is a critical determinant of a country’s debt servicing capacity. A strong economy is expected to broaden the economic base and boost resources to service external debt. It can minimize the likelihood of external indebtedness (Mater et al., 2025; Maddah et al., 2024; Ho and Iyke, 2020). For instance, Baniata et al. (2023) found that a percentage growth in real GDP is expected to reduce external debt by 0.47%. In line with real GDP growth, a strong fiscal space is significant for external debt servicing. Drawing from the experiences in Sub-Saharan Africa, Azolibe (2022), Ho and Iyke (2020), and Oyedele et al. (2013) reported that sluggish fiscal trends can heighten external indebtedness in these countries. It is important to expand the country’s revenue base to generate more resources to pay off external debts (Nissanke, 2013). This is further supported by Gaspar et al. (2019), who argued that achieving the UN Sustainable Development Goals for low-income countries will require increasing domestic revenues by roughly 15% of GDP. According to Attard (2019), higher government debts are expected during an economic crisis because of lower tax revenue and higher public spending. Efuntade and Efuntade (2022) reiterated that a high debt servicing ratio, such as Nigeria’s 97% in 2021, indicates significant fiscal challenges. Reis (2022) emphasizes the need for effective revenue mobilization and fiscal management to ensure debt sustainability, especially in the context of rising public debt levels.

A country’s ability to earn foreign exchange through exports also plays a crucial role in determining its ability to service its debt (Jonasson et al., 2024). Studies have also shown that countries that prioritize a diverse range of exports can reduce their debt service ratios by increasing the stability of earnings and reducing the risk of price volatility (Delechat et al., 2024). However, this is yet to be the case in many Sub-Saharan African countries, partly due to the instability of their export commodities (Abdel-Latif et al., 2025). Domestic savings are key for countries to improve their debt sustainability and rely less on borrowing from other nations. Higher savings rates can help countries in managing and paying off external debts more effectively (Mahmood et al., 2014). Karia (2021) also mentioned that an increase in domestic savings will lead to a drop in external debt. Similarly, Kose et al. (2020) noted that encouraging companies to save more could improve debt sustainability. FDI also plays an important role in external debt servicing. According to Aizenman and Sushko (2011), FDIs can generate almost 40% of private inflows into developing countries. They promote economic growth by providing local employment, boosting export competitiveness and enhancing technological capabilities (Ndoricimpa, 2014). However, an FDI that crowds out domestic investment will have a negligible effect. Alvarado et al. (2017) pointed out that FDI tends to have more positive effects in countries with strong financial markets and the capacity to absorb its requirements.

In conclusion, previous studies largely focused on the determinants of the servicing capacity of indebted countries and the relationship between external debt and key macroeconomic variables. The results are somewhat mixed in both developing and advanced economies, with some highlighting positive effects and others pointing out their detrimental consequences. In recent times, the vagaries of global financial trends and the varying degrees of economic challenges faced by countries across the globe have heightened the discourse on external debt sustainability. This raises the issue of debt servicing capacity, especially for low-income countries, an area of the literature that is still exploratory. To help narrow this gap, we consider the changes in macroeconomic trends over time to evaluate the enhancers and reducers of the external debt servicing capacity of Sierra Leone in the context of asymmetric effects. By drawing from the empirical evidence on external debt and the study’s theoretical framework, we posit the following hypothesis:

Main hypothesis: Boosting FDI and exports will enhance the country’s external debt repayment capacity.

Yearly time series data spanning 1960 to 2024 were obtained from the World Bank country data of Sierra Leone for real gross domestic product (RGDP), export (EXP), FDI, gross domestic savings (GDS) and EDS). The data on revenue (TR) is collected from the National Revenue Authority, the IMF (2020, 2024), and the World Bank (2023, 2024) over the study period. The EDSR is the EDS divided by the revenue (TR) in that year to measure the debt repayment capacity of the country ^[1]. We evaluate how an increase or decrease in each of these market variables would impact the country’s capacity to service its external debt.

Preceded by a unit root test to establish the level of stationarity in the variables, an auto-regressive dynamic lag (ARDL) Bounds test developed by Pesaran et al. (2001) was used to check for cointegration of the variables. As the macroeconomic outlook of Sierra Leone has exhibited significant changes over the study period, the nonlinear auto-regressive dynamic lag (NARDL) developed by Shin et al. (2014) was deployed to explore the asymmetric effects of RGDP, EXP, FDI and GDS on the EDSR. The ARDL Bounds test allows for a mix of both first-degree stationary I(1) and non-stationary I(0) variables in the model. It also performs better even in small samples (Narayan and Narayan, 2005; Bangura and Lee, 2023). The advantages of NARDL over other dynamic models further include the model’s capacity to examine the asymmetric effects (as it captures both positive and negative changes) of the explanatory variables on the dependent variable, and it can estimate the long-run relationship between variables whether stationary or not (Yeap and Lean, 2017; Bangura and Lee, 2023). Since the study aims to examine the relationship between Sierra Leone’s external debt servicing capacity and changes in key economic variables, the NARDL is appropriate as it estimates the effect of a downward and upward change in each of the explanatory variables on the dependent variable. We define an enhancer as a positive net effect of the asymmetric effects, while a negative net effect is a reducer. Following Pesaran et al. (2001), the study’s linear ARDL model becomes:

From Equation (1), α₀ is a constant, α_1-5 are the long-run parameters, β_1-5 are the short-run parameters, and k is the optimal lags of the variables in difference. From Equation (1), the cointegration test requires an error correction model defined as follows:

From Equation (2), _λτt-1 is the error correction term (ECT), _λ is the cointegration parameter, Δ denotes the difference factor, and it represents the short-run effects. We test the null hypothesis of no cointegration as follows H₀: α₁ = α₂ = α₃ = α₄ = α₅ = 0 against the alternative hypothesis of cointegration H₁: α₁ ≠ α₂ ≠ α₃ ≠ α₄ ≠ α₅ ≠ 0. The optimal lag, k, is determined using the Schwarz information criterion (SBC), Akaike information criterion (AIC) and Hannan-Quinn information criterion (HQ). Using the F-test recommended by Pesaran et al. (2001), the null hypothesis is rejected if the F-statistic is greater than the upper bound, revealing cointegration, while a non-rejection of the null hypothesis occurs when the F-statistic is below the lower bound, indicating the lack of cointegration between the variables. If the F-statistic is between these two bounds, the results become undefined (Pesaran et al., 2001).

The previous discussion on the ARDL was premised on the NARDL, which is used to capture the short-run and long-run asymmetric effects of market fundamentals on the EDS ratio. According to Shin et al. (2014), the asymmetric equation is defined by decomposing the vector of explanatory variables (V_t) into their positive (+) and negative (−) partial sums of increases and decreases as follows:

Following the methodology by Shin et al. (2014), the nonlinear asymmetric ARDL model can be represented as:

From Equation (6), α⁺ and α⁻ are the long-run coefficients associated with positive and negative changes, respectively, from the vector of explanatory variables (which are RGDP, EXP, FDI and GDS). Shin et al. (2014) further demonstrated that by incorporating Equation (6) in the ARDL model presented in Equation (1), we obtain the following nonlinear asymmetric NARDL equation as follows:

From Equation (7), the elasticity of coefficients of the vector of variables V_t⁺ and V_t⁻ is computed as:

The error correction model of Equation (7) becomes:

FromEquation (8), (φψ_t−1) estimates the equilibrium asymmetric relationship and (_φ) captures the speed of adjustment aftershocks. The short-run asymmetric effects are captured by the coefficients $βi2−5+$ and $βi2−5−$ for positive and negative changes, respectively. Since the estimation procedure of the NARDL is the same as the linear ARDL, we test the existence of cointegration in the NARDL model following the steps discussed earlier. The Wald test is used to obtain the long- and-short-run symmetries. For the long run symmetry, the null hypothesis H₀: π⁺ = π⁻ is tested against the alternative hypothesis H₁: π⁺ ≠ π⁻. For the short run symmetry, the null hypothesis becomes H₀: $∑i=0kβi2−5+=∑i=0kβi2−5−$⁠.

We begin our analysis with a statistical description of the variables used in the study. The summary statistics of these variables are reported in Table 3. The clear differences between the maximum and the minimum values and the standard deviation of these variables indicate differing levels of variation over time. The fluctuating nature of these variables further validates the use of NARDL to determine the enhancers and reducers of external debt servicing capacity.

From Table 4, the Augmented Dickey–Fuller unit root results show that EDSR is stationary on the level at 1%, while real GDP, EXP, FDI and GDS are stationary after the first difference. The mixed results of stationarity in the variables further validate the appropriateness of the NARDL Bounds cointegration test.

The NARDL Bounds cointegration results are reported in Table 5. We found evidence of cointegration in the model as the F-statistic of 13.87 is greater than all the upper bound levels of significance, including the 1%. This shows the existence of a long-run relationship between EDSR and its explanatory variables. The cointegration results confirm the application of the error-correction NARDL model. Further to our diagnostic and asymmetric analyses, we conducted a multicollinearity test to check the relationship across the explanatory variables ^[2].

The long-run and short-run error-correction NARDL results are reported in Tables 6and 7, respectively, and they present the asymmetric effects of each of real GDP, EXP, FDI and GDS on the country’s capacity to service its external debt. This separates the effect of each of these explanatory variables by examining the positive and negative partial sums and estimating their effect on Sierra Leone’s capacity to service its external debt. The variables are in logarithmic form and, as such, they represent elasticities.

From the long-run results in Table 6, real GDP is statistically significant at the 1% level for both positive and negative asymmetric changes. The results demonstrate that a 1% increase in real GDP^pos(+) is expected to enhance the EDS capacity of the country by 0.25%, while a percentage drop in real GDP^neg(−) will reduce the country’s capacity to service its external debt by 0.05%. The positive impact of a 1% increase in real GDP on debt servicing capacity is almost four times greater than a 1% decline in real GDP. These differences in the magnitude of the positive and negative effects highlight the importance of promoting economic growth to enhance a country’s capacity to service its external debt. Improving real GDP will potentially broaden the economic base and improve the tax revenue of the country. The country’s fiscal space will be reinforced, reducing the likelihood of raising external debt stock while also boosting its capacity to service external debt. The findings echo Holland and Pazarbasioglu’s (2024) IMF blog on the importance of widening the economic base to ease the external debt servicing pressures on low-income countries. Export also demonstrates uneven effects, as a percentage increase in export (EXP^pos(+)) is expected to raise the external debt servicing capacity of the country by 0.02%, while a drop in export (EXP^neg(−)) will lower such capacity by 0.11%. This indicates that the adverse effect of a decline in exports on external debt servicing is more than four times greater than the positive effect of exports on the country’s debt servicing capacity. Any drop in the volume of exports could significantly affect the country’s capacity to service its external debt and increase the risk of default to its external loan providers. This is intuitively appealing as export is a major source of the foreign currency required to service the country’s external debt, so a drop will adversely affect debt service. It shows how the volatility in the value of exports over the years, whether due to the civil conflict, Ebola outbreak, COVID-19 pandemic, global shocks or structural changes, has adversely affected the debt servicing capacity of the country. This points out the importance of increasing export volume to promote economic growth and enhance repayment capacity and foreign reserves (Khan et al., 2021; Xingwang and Steiner, 2017).

FDI is another statistically significant determinant of external debt servicing capacity with asymmetric effects. An increase in foreign direct investment (FDI^pos(+)) by 1% is expected to improve the country’s capacity by almost 0.02%, while a 1% decrease in (FDI^neg(−)) will narrow the country’s capacity to service its external debt by 0.06%. Similar to export, FDI inflow will increase foreign currency in the country and, as such, any hindrance to an effective and supportive investment climate will deter the capacity of country to service its external debt. For instance, according to the AfDBG 2020 Country Strategy Paper, the suspension of mining licenses in 2019 due to concerns about breaches in contractual agreements took a toll on the mining sector and the country’s overall economic growth. Despite the existing bilateral investment treaty between Sierra Leone and the United Kingdom [UK], the US Department of State (2021) reported a blatant violation of such treaty by the Government of Sierra Leone as they failed to comply with the rulings of the International Chamber of Commerce in a mining dispute with a USA/UK registered firm. Such a situation may adversely affect exports and the flow of foreign currency, limiting the capacity of country to service its debt. GDS also exhibits asymmetric effects, though the negative effect (GDS^neg(−)) is statistically insignificant, while a 1% increase in gross domestic savings (GDS^pos(+)) is expected to boost the country’s capacity to service its external debt by almost 0.08%. The results show the importance of increasing aggregate savings to expand the loanable funds of financial institutions. This could stimulate private investment and contribute to the country’s GDP.

The short-run results in Table 7 also show an asymmetric change in real GDP, revealing significant effects for both positive and negative changes. Again, the effect of an increase in real GDP^pos(+) exceeds the effect of a drop in real GDP^neg(−) by almost twofold. Conversely, for export, the adverse effect of a decline in export (EXP^neg(−)) is 1.6 times greater than its positive effect (EXP^pos(+)). In the case of FDI, the symmetric change is only significant for the positive change, while there is no significant symmetric effect for GDS. This demonstrates that investment decisions in most cases are not instantaneous, so the conversion of savings into investment may take some time. The estimated error-correction term (ECM_t-1) is negative and empirically significant at the 1% level, indicating that a 64% correction to the equilibrium is made in the following year.

Our diagnostic results in Table 8 show that the model has 78% explanatory power as revealed by the R-square and the p-value failed to reject the tested hypothesis of no serial correlation. The null hypothesis of no heteroskedasticity is also not rejected. The result also failed to reject the null hypothesis of the normality test, showing that the data is normally distributed. The Wald test results reported in Table 9 show empirical evidence of asymmetric effects of all the explanatory variables on the EDS ratio. The diagnostic results reveal that the model is generally a good fit, and the Wald test shows that the NARDL is reliable and appropriate.

Our results have revealed three important caveats. First, this study found real GDP to be a significant driver of the external debt servicing capacity of Sierra Leone in the short and long run. The positive effect of a 1% increase in real GDP is almost four times the negative effect in the long run and almost two times greater than the negative effect in the short run. These results are supported by World Bank (2020) country data, as Sierra Leone’s headline economic growth of more than 20% in 2013 resulted in a 32% increase in debt service on external debt from 2012 to 2013, even though external debt stock only increased by 4.68% during the same period. These findings are also consistent with Holland and Pazarbasioglu (2024), and Saungweme and Odhiambo (2020), who argued that economic prosperity is a critical determinant of a country’s capacity to manage its public debt. Second, a drop in exports is not great news for Sierra Leone, as its adverse effect on the country’s capacity to service its external debt is more than four times greater than its positive effect in the long run and 1.6 times greater than the positive effect in the short run. Increasing exports will generate foreign currency and foreign reserves and put the country on a better footing in terms of meeting its debt obligations. This is supported by Jeetoo (2022), who highlighted the role of export revenue in foreign debt service in Sub-Saharan Africa and further reported that higher export earnings will reduce the need for external borrowing. Third, boosting FDI, another source of foreign currency, is also an important step in improving a country’s capacity to service its external debt. These results generally reveal that economic prosperity triggered by the significant improvement in exports and FDI is critical in enhancing the capacity of Sierra Leone to finance its external debt. These findings support the study’s main hypothesis–boosting FDI and exports will enhance the country’s external debt repayment capacity.

As public expenditures continue to exceed revenue, most low-income countries continue to explore alternative sources of financing for their budgetary needs. As local borrowing becomes difficult due to fears of crowding out private investment, governments of many countries have resorted to external borrowing, which raises their levels of indebtedness. More recently, serious concerns have been expressed by international financial institutions like the World Bank, the IMF and the AfDBG about the sustainability of these loans, especially in low-income countries. This brings the issue of external debt servicing to the forefront. However, much of the literature on debt servicing looks more at its severity, trends, and its link with structural reforms. The literature on the drivers of external debt servicing is limited.

We narrow this gap by examining the drivers of Sierra Leone’s capacity to service its external debt using time series yearly data from 1960 to 2024. We employed the non-linear ARDL model to estimate the asymmetric effects of real GDP, export, FDI and GDS on the capacity of the country to finance its external debt. Three key findings have been documented. First, economic prosperity, measured by real GDP growth, is empirically significant in enhancing the country’s capacity to finance its external debt. Over time, a one percent increase in real GDP has a positive effect of almost four times greater than the negative effect of a decline in economic activities. Second, there is evidence that export boost is a statistically significant contributor to the enhancement of the country’s capacity to service its external debt. However, in both the long run and short run, a decrease in exports will cause a significant deterioration in the country’s capacity to finance its external debt. Third, the results of FDI indicate that increasing capital flows to the country and reinvestment of earnings would enhance the country’s capacity to service its external debt. Any drop in FDI would have a devastating effect on the servicing capacity of the country. In general, promoting economic prosperity through exports and FDI is an important step in improving the debt servicing capacity of Sierra Leone.

These findings have significant implications. Policymakers could use these findings to tailor targeted economic policies that aim at addressing the high level of indebtedness in a country. Lending institutions could use these findings to conduct borrowing capacity assessments of lending countries. The findings could also inform or encourage central governments to channel external debt to more productive sectors to boost the country’s economy and enhance its capacity to finance its debt. Drawing from the study findings and implications, we propose a dual economic policy that promotes export drive and improves the business environment of the country to propel economic growth and boost investment and foreign currency. This could be done by executing a local economic development strategy to boost commercial activities in the sectors with comparative advantages. This could be complemented by enhancing initiatives toward a one-stop shop backed by a good road network and reliable electricity for foreign investors. This array of economic approaches will enhance the country’s capacity to service its external debt. This study is limited only to Sierra Leone due to its macroeconomic situation. As other developing countries may also experience fluctuating trends of macroeconomic variables, future studies may focus on a panel of African countries for a more comprehensive insight at the continental level.