Heterogeneous effect of external debt on capital flight: Evidence from lower-middle-income countries

Type of the article: Research ArticleAbstract Capital flight remains a paramount concern for lower-middle-income countries (LMICs) when securing external debt, as its volume and the country's economic vulnerability can heighten this concern. This study aims to investigate the heterogeneous effect of external debt on capital flight across 42 lower-middle-income countries from 2004 to 2023. Methodologically, we applied the Methods of Moments quantile regression (MM-QR) approach, benchmarking our estimates against static fixed effects and two-step system Generalized Method of Moments (GMM) models. The panel quantile regression shows that capital flight increases in tandem with external debt; however, the positive impact of external debt on capital flight is more pronounced in the lower quantiles and less pronounced in the upper ones. The quantile estimates reveal a highly heterogeneous relationship, with the positive impact of external debt almost doubling from 1.671 at the 90th quantile to 2.663 at the 10th quantile. Ultimately, these findings suggest policymakers must implement targeted, tier-specific debt management strategies to contain capital flight effec-tively, and adopt adequate infrastructure to detect misinvoicing, fake shipments, manipulation of transfer pricing, moral hazard problems, and weak economic governance.