Is Public Debt Harmful Towards Economic Growth? New Evidence from Sri Lanka

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.