2019-03: An Empirical Analysis of the Impact of Total Debt on the Economic Growth of Sri Lanka (Working paper)

Public debt is one of the key fiscal policy variables that can be influence the economic growth of any country. For this reason, policymakers and economists have worried about the relationship between debt and growth. Empirical studies of the relationship between debt and growth have, however, been recently contested because of their mixed results; negative vs positive and linear vs non-linear. Moreover, some researchers have found a non-linear relationship. There are several main theoretical perspectives which underpin this relationship between debt and growth. In the Keynesian view, debt and growth are positively related. However, Monetarist economists argue debt and growth have a negative relationship. Sri Lanka has accumulated a large amount of debt over the past six decades from both domestic sources and external sources. Accordingly, the main objective of this study is to assess the impact of public debt on economic growth in Sri Lanka using time series data from 1960 to 2016. Other specific objectives are to identify the relationship between total domestic debt and external debt on economic growth and to identify significant policy implications and make suggestions to enhance economic growth. Thus, this study involves two analysis stages. The first one is an aggregate analysis, which assesses the impact of total debt on economic growth. The second one is a disaggregate analysis, which assesses the impact of domestic debt and external debt on economic growth separately. This study implements the Structural Vector Auto Regression (SVAR) approach to examine the impact of public debt on GDP growth in a short-term as well as medium-term in Sri Lanka. This study confirms that total debt has a negative impact on GDP growth in Sri Lanka. In addition, based on the disaggregate analysis, we can conclude that domestic debt has a negative and significant linear relationship with GDP growth in Sri Lanka and external debt has a positive but insignificant relationship with GDP growth in Sri Lanka. Moreover, this study ...