Abstract:
Economists have observed in recent times that Sri Lanka’s external sector has become
very vulnerable to the Balance of Payment crises due to soaring external debt stock
along with the rise of external debt servicing. Given such a backdrop, this paper
investigates the impact of external debt on Sri Lanka’s Gross Domestic Product. The
study adopts the Autoregressive Distributed Lag (ARDL) econometric model to
estimate the impact of Gross Domestic Capital Formation, Gross Domestic Savings
and external debt on GDP. Estimates indicate that a 10% increase of Gross Domestic
Capital Formation resulted in 3.6% increase of GDP, while a 10% increase of Gross
Domestic Savings resulted in a 1.3% growth in GDP. However, as per the estimates, a
10% increase in external debt stock resulted in reducing GDP by 1.7%. The
regression estimate results are supported by the literature. A number of studies
conducted to identify the relationship between external debt and economic growth in
developing countries suggest that an increase of external debt affects GDP adversely.
This study attributes the negative relationship between external debt and GDP growth
to the massive external debt servicing payments, resulting in foreign reserve outflows
which causes a contracting of public investment. It is observed that raising money by
issuing Sovereign Bonds (categorized as commercial borrowings) has a significant
impact on increasing external debt servicing payments because interest in such
commercial borrowings is high. Government finance figures show that, as the debt
servicing cost rises, capital expenditure of the government has fallen, reducing
investment in the economy.
