Foreign aid and growth nexus: Empirical evidence from India and Sri Lanka

Abstract

This paper examines the relationship between foreign aid and economic growth for India and Sri Lanka using annual time series data from 1960–61 to 2014–15. This study uses various time series techniques such as Johansen–Juselius test, Granger causality test and VAR modelling to find out the short-run and long-run equilibrium dynamics among the variables under consideration. The empirical results confirm that long-run relationship exists among foreign aid inflows, economic growth, trade, inflation, domestic investment and financial development in India. There also exists an uni-directional causality among the variables for the same. However, in Sri Lanka, foreign aid does not have a significant impact on growth, both in the long-run and short-run. The governments of the respective countries are thus required to make efforts in employing proper monetary and fiscal policies in order to stabilize the domestic economic cycle as well as external economic transformation in accordance with the impact of foreign aid on economic growth in each of them.