Twin deficit hypothesis: The case of Sri Lanka
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Date
2024-08
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University of New Brunswick
Abstract
The relationship between current account balance and fiscal balance in Sri Lanka between 1960 and 2022 is examined using annual data. Stationarity of data series was checked using the Augmented Dicky Fuller Test and the Philips – Perron Test. In order to investigate the long run relationship between current account balance and fiscal balance, the autoregressive distributed lag (ARDL) model and bound tests is applied. Under an ARDL model a bound test provides statistical evidence of a long run relationship between the current account balance and fiscal balance. Error correction form of the ARDL model shows that fiscal balance and GDP growth rate have a statistically significant impact on the current account balance in the long run. The Granger causality test provides evidence that the direction of causality ran from the budget deficit to the current account deficit. Recommendations for improving the current account balance by improving the fiscal balance and changing the growth trajectory of Sri Lanka are discussed.