EMPIRIC ANALYSIS OF EXTERNAL DEBT IN CROATIA: VAR MODEL APPROACH

The sharp rise of external debt in Croatia in the last decade was the result of different endogenous and exogenous factors of external indebtedness. The share of gross external debt to gross domestic product has exceeded the ratio of 100 percent while worsening other indicators of external debt. Symbolically speaking the problem of external debt hangs like a Damocles sword over the Croatian economy. The aim of this paper is to explore the interdependence between the factors which led to a sharp increase of foreign debt in Croatia and to suggest the measures to overcome the problem of indebtedness. Determinants of external debt used in the econometric analysis are merchandise trade deficit, real effective exchange rate, interest rate differential and the budget deficit. In order to investigate the dynamic interdependence between the variables econometric VAR model was built. It assumes that all variables in the model are potentially endogenous. Granger causality test was used to determine the correct order of variables in factorization while the test of impulse responses explains the reaction of the gross external debt to two standard deviation changes in key variables in the short and the long run. The results of Granger causality tests have shown that there is a causal relationship in the direction from budget and merchandise trade deficit to gross external debt. On the other hand, there is a causal relationship in the direction from the gross external debt to interest rate differential. Forecast error variance decomposition has shown that the greatest importance in explaining the variability of the gross external debt has budget deficit and current account deficit.