Credit Intensity of Economic Growth – A Sectoral Analysis: Case of Sri Lanka

This paper examines the dynamic relationship between credit and economic growth in Sri Lanka using aggregated and disaggregated data for the period 2003-2015 in an attempt to decipher the ‘credit-GDP growth puzzle’ experienced recently. The Unrestricted Vector Autoregression (UVAR) approach is followed to account for dynamics and causality tests conducted to determine the direction of the causality between real output and private credit. This is followed by a multiplier analysis to ascertain the direction, timing, magnitude and sensitivity of economic growth to unexpected shocks in private credit. We find evidence supporting the ‘demand-following’ hypothesis, and varying responses of real output to credit shocks at aggregate, sectoral and sub-sectoral levels imply the presence of sectoral heterogeneity to credit impulses. It is therefore imperative that policymakers account for these factors when formulating appropriate (stabilisation) policies to achieve its ultimate objective of price and economic stability.