Impact of Public Debt on Economic Growth: An Econometrics Analysis of Sri Lanka

Abstract

Public debt is a major factor in a country’s global ranking, as it is a key indicator of macroeconomic performance. Many countries have investigated how public debt affects economic growth, but the impact of public debt varies from country to country. Therefore, it is important to conduct individual studies for each country. This research focuses on Sri Lanka and examines the impact of public debt on economic growth using the latest available data from 1990 to 2022. The Gross Domestic Product has been used to measure the Economic Growth in this study The data of Gross Domestic Product, Public Debt, Budget Deficit, Exchange Rate, Inflation Rate, Interest Rate, Government Expenditure and Debt Growth Rate were collected from annual reports of Central Bank of Sri Lanka. The ADF and PP unit root tests confirmed that none of the variables are I (2), which allow to examine co-integrating relationship among the variables using ARDL Bound testing method. The ARDL Bound testing result confirmed that there is a co-integrating relationship between the variables. Further this test suggests that Public Debt has negative and significant impact on Economic Growth in the long run. The Error Correction Model found that Debt has negative and significant impact on Economic Growth in the short run. Granger Causality Test reveals that uni-directional causality runs from Public Debt to Economic Growth. Finally, the results of this study show that Public Debt negatively effects on Economic Growth. At the same time there is a uni-direcrional causation between these two variables. This conclusion emphasizes that, to improve Economic Growth, Public Debt could be used as a policy instrument. This study recommends that the Sri Lankan government needs to have some limitations regarding the level of borrowing due to adverse effects on economic growth and effective usage of public debt is essential for Sri Lanka.