The Impact of External Debt on Foreign Direct Investment in Sri Lanka

Abstract

Introduction :

Foreign Direct Investment (FDI) is an important avenue to earn foreign exchange, resolve the external debt problem, and promote economic growth. The literature has revealed that FDI is influenced mainly by external debt and also other factors such as inflation rate, interest rate, and trade openness (Muzurura, 2016). A high level of external debt results in harmful effects on an economy by reallocating FDI from productive investment to resolving external debt issues (Krugman, 1988). Hence, the relationship between external debt and FDI is considered an important factor since the developing countries are highly dependent on foreign debt to accelerate economic growth and fulfill their development needs (Mugambi, 2016).

In Sri Lanka, the Government’s debt to GDP ratio was increased by 76.9% while FDI was increased by only 17.3% in 2017 while in 2018, the foreign debt recorded one of the largest increases since 1977 (Central Bank of Sri Lanka, 2018). It is noted that attracting FDI is an essential strategy to earn foreign reserves to pay the external debt and solve the public debt problem in Sri Lanka. Therefore, finding solutions to maintain public debt and attract FDI becomes an issue of high concern in the country. However, the relationship between external debt and FDI has not been explored widely in Sri Lanka. Hence, this research attempts to examine the impact of external debt on FDI and expected to provide a very important role in the current public debt problem as well as FDI flows in Sri Lanka.