The relationship between macroeconomic variables and budget deficit: A comparative study of Sri Lanka with Malaysia and South Korea

Abstract

The association between budget deficit and macroeconomic variables and their repercussion on macroeconomic instability has been the most widely debated topic among economists and policymakers. This paper examines the association between budget deficit and selected macroeconomic variables in Sri Lanka, Malaysia and South Korea, 2000-2016. Explanatory macroeconomic variables are inflation, interest rate, exchange rate, debts, and real GDP growth rate. The Granger Causality test was carried out to determine whether the selected variables’ impact on budget deficit were uni- or bi-directional; the comparative study considered panel analysis. Data were sourced from the IMF, World Bank and annual reports of the Central Bank of Sri Lanka. The Sri Lankan finding was that there was uni-directional causality between variables. In the Malaysian study, there was no causality between budget deficit and the variables. In South Korea, the study identified uni-directional causality between variables. The panel analysis suggested that debts and real GDP growth rate are significant variables in controlling the budget deficit. A country’s debt level is a significant variable in controlling the size of the deficit. For Sri Lanka, it is important to consider economic policy strategies implement by Malaysia and South Korea to mitigate prevailing economic issues of a sustained sizable budget deficit, significant debt maturities, weaker public finances, higher domestic and foreign currency debt.