Abstract
This study examines the impact of public debt on economic growth and investment in Sri Lanka during the period from 1977 to 2017. The two model specifications, growth model and investment model, are estimated using the Johansen Cointegration technique and the Vector Error Correction Model (VECM) specified under the Vector Auto Regressive (VAR) framework using annual data for the period of 1977-2017. The results of the two models reveal that public debt, which consists of foreign debt and domestic debt, has a significant and positive impact on economic growth and investment in the long run. In the short run, a significant association between public domestic debt and economic growth as well as total public debt and investment is observed, suggesting mixed results. Debt service payments in the long run show a significant negative effect on both economic growth and investment, reflecting a crowding out investment. The finding suggests that using government debt for priority investment expenditures with a prudent debt management strategy to curtail the impact of crowding out investment will have a favourable impact on economic growth of the country, particularly in the long run.
Highlights
The impact of public debt2 on economic growth is a controversial and debated issue in many countries, in developing economies (Deshappriya 2012)
Similar to the long run, it is evidenced from the short run results that debt indicators such as total public debt and debt service payments have a significant influence on investments in the country
Two model specifications namely growth model and investment model were estimated applying Johansen Cointegration and the Vector Error Correction Model (VECM) technique specified under Vector Auto Regressive (VAR) model
Summary
The impact of public debt on economic growth is a controversial and debated issue in many countries, in developing economies (Deshappriya 2012). There is no consensus as to whether public debt affects economic growth positively or negatively Academic opinion on the impact of public debt on economic growth can be divided into three stands (Munir 2015; Oleksandr 2003). The first stand is that there is a positive association between public debt and economic growth. The second stand suggests a negative correlation between public debt and economic growth (eg., Atique 2012; Mhlaba 2017; Akram 2016). Higher accumulation of public debt adversely affect on economic growth as described by the “debt overhang” effect,
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