Relationship between Domestic Debt and Gross Domestic Product in Sri Lanka (A Time Series Analysis)

With the current development of country, Sri Lankan Domestic Debt level has been increasing since 1960 (Central Bank, 2009). But care should be taken on escalating Domestic Debt level of country as it threats on internal economic policies through continuous budget deficit, crowding private investment, absorbing large GDP for payments (Central Bank of Sri Lanka, 2010). The main objective of this study was to examine the relationship between domestic debt and economic growth of Sri Lanka. Moreover, the paper discusses the reasons, why domestic debt level of Sri Lanka has been increasing since 1960. In order to realize the aforesaid objectives, the study applied Multiple OLS regression technique for the time series data on Domestic Debt and Economic Growth of Sri Lanka. The relevant data for the period from 1960 to 2009 were collected from Central Bank reports. The OLS model was estimated based on Unit root Test and Normality Test. The estimations were revised with certain modifications depending on the results from post-estimation tests including Multi-collinierity, Normality, Heteroskedasticity tests and Auto-correlation test. The regression showed a non linear inverted “U” shape relationship between Domestic Debt and Economic Growth. Accordingly, Domestic Debt volume is maximized when the country's GDP growth rate is 5.93 per cent. As well as it implied a U-shape non-linear statistically insignificant relationship between interest rate and domestic debt over period. Further, the study found that escalating domestic debt was fueled by continuous budget deficit, big government involvement, depreciation of domestic currency, higher demand for domestic debt and prevailed war of country. Finally, it should be noted that a deeply constructed time series analysis may provide vital estimations on how domestic debt volume and GDP growth rate are linked together. However, the analyses used in this study are confident enough at least to say that domestic debt growth is determined by country's GDP growth rate. Effective exchange rate policy with sharp fiscal and monitory policy and minimum government intervention are required to minimize domestic debt growth rate and proper debt management policy and fare distribution policy are needed for debt sustainability