Does Foreign Borrowing Lift Growth?

External borrowing by governments is widely viewed as an important instrument for financing development, yet its growth effects remain controversial. We exploit the bilateral structure of public sector lending relationships to construct plausibly exogenous foreign credit supply shocks, isolating changes in borrowing capacity arising from creditorspecific shifts in lending rather than borrower demand. Using data covering 134 developing economies over 1970-2023, we show that positive foreign credit supply shocks lead to persistent increases in public investment and external indebtedness. However, easier access to external public sector finance does not, on average, generate sustained improvements in output or productivity and is accompanied by real exchange rate appreciation, weaker external balances, and partial crowding-out of private investment. The macroeconomic benefits of external public sector borrowing depend critically on institutional quality. Countries with stronger institutions translate additional borrowing into more favorable productivity and output responses, while accumulating more public capital and relying less on domestic financing. Our findings suggest that greater access to external finance is not, by itself, sufficient to boost development. The effectiveness of public sector borrowing depends fundamentally on the institutional capacity to allocate and manage borrowed resources productively.