Economic determinants of budget deficit in Sri Lanka

Abstract

Introduction Deficit budget was adopted in both developing and developed countries to adjust macroeconomics policies in 1980s. When considering about Sri Lankan situation, data shows that budget deficit varies between 5 to 10 % of GDP over the last few decades (Central Bank Report, 2014). According to the economic theory, if budget deficit exceeds around 8 % of GDP, it is not a favorable condition for the economy as it creates adverse effects such as reduces national savings, increases borrowings, crowding out and inflation. Therefore, it is worthwhile to understand the reasons behind the budget deficit. Among the empirical studies, Chihi and Normandin (1960) found that there is a positive co-movement between external trade and budget deficits. Chowdhury and Saleh (2007) explained that current account deficit, savings–investment balance and budget deficit have positive long run relationship. Anojan (2014) concluded that direct tax revenue significantly affect to the budget deficit in Sri Lanka. Given this background it is important to identify the important determinants of budget deficit in Sri Lanka.