Dynamics of Public Debt Sustainability and Economic Growth: The Case of Sri Lanka

Abstract

Over the past decades, most of the developing nations in the world have to face a critical issue of rising public debt. In Sri Lanka, public debt has increased to a higher level during the post liberalization period. Debt can be influenced economic growth and general welfare of the public only it is used properly without transferring additional burden on public. Therefore, it is beneficial to evaluate the short run and long run effect of debt on economic growth and its sustainable level. Hence, this study examines the dynamics of debt sustainability and the impact of public debt on economic growth in Sri Lanka using annual time series data for the period 1960-2018. This study uses deductive research approach and the model framework develops based on the literature. This study adopts econometric procedures to find out the short run and long run effect of internal and external public debt on economic growth in Sri Lanka and the sustainability of public debts analyze using graphical analysis with the support of the past literature. The econometrics procedure follows unit root test, co-integration tests and vector error correction mechanism together with granger causality test to investigate short run and long run effects of debt on growth. Empirical findings of the study revealed that internal and external public debt has positive impact on economic growth in the long run confirming crowding in effect of investment. Further, Gross domestic capital formation and government expenditure has positive impact on economic growth in the long run. The coefficient of Error Correction Term (ECT) suggests disequilibrium in the real GDP growth is corrected at the speed of 58 percent annually confirming the existence of long run relationship between debt and growth. Granger causality test confirmed uni-directional causality running from real economic growth to internal public debt in Sri Lanka. The sustainability of public debt in Sri Lanka is not in a good position as most of such measures reflect unfavorable trend over the last period. Finally, the finding of the study is useful to the policy makers to design and implement appropriate policies to achieve desired level of economic growth for the country.