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Subnational Regional Growth, Debt Thresholds and Sustainability

This research employs Mexico’s state level data from 2001-2016 to examine the nexus between debt sustainability and regional economic growth. Following the ideas of Reinhart and Rogoff 2010 and Ilzetzki, et al 2019, the research seeks to establish the threshold between debt and regional growth. There is a need to understand whether increasing debt exerts benign effects on regional GDP growth in centralized fiscal systems prevalent in emerging countries and whether these effects differ by type of financing. The study employs the dynamic panel approach by Arellano and Bond (1991) to control for different types of endogeneity and the Seo and Shin (2016) kink model to estimate debt thresholds. The results point to a weak but positive association between debt and GDP growth, which differs by type of debt. Subnational debt thresholds of local governments locate at 67% as a share of guaranteed resources–lower than those reported at the national level. Employing debt as a share of GDP we find a much lower debt threshold (3.25%) which is explained by the fiscal interrelations architecture of federal systems with high local government dependence on federal transfers and subject to soft budget problems. The study finds economic growth is more sensitive to commercial bank debt and capital market debt than other types of debt.