Dynamic inter-linkage between foreign aid and economic growth in Sri Lanka

Purpose: The objective of this study is to explore the dynamic inter-linkage between foreign aid and economic growth in Sri Lanka over the period of 1960–2018. Design/methodology/approach: Both exploratory and inferential data analysis tools have been employed to examine the objective of this study. The exploratory data analysis covered the scatter plots, confidence ellipse with kernel fit. The inferential data analysis included the augmented Dickey–Fuller (ADF) and Phillips–Perron (PP) unit root tests, the autoregressive distributed lag (ARDL) Bounds co-integration technique and the Granger causality test. Findings: The test result of exploratory data analysis indicates that there is a positive relationship between foreign aid and economic growth. The ADF and PP unit root tests results indicate that the variables used in this study are stationary at their 1st difference. The co-integration test result confirms the presence of long-run relationship between foreign aid and economic growth in Sri Lanka. The estimated coefficient of foreign aid in the long-run and the short-run shows that foreign aid has a positive relationship with economic growth in Sri Lanka. The estimated coefficient of error correction term indicates that approximately 26.6% of errors are adjusted each year and further shows that the response variable of economic growth moves towards the long-run equilibrium path. The Granger causality test result shows that foreign aid in short-run Granger causes economic growth in Sri Lanka which means that one-way causality from foreign aid to economic growth is confirmed. Further, the estimated coefficient of error correction term confirms that there is the long-run Granger causal relationship between foreign aid and economic growth in Sri Lanka. Practical implications: The findings of this study have some important policy implications for the design of efficient policy related to foreign aid and economic growth, the knowledge of which will help follow sustainable foreign aid and growth nexus. Originality/value: This study contributes to the existing literature by using the newly introduced ARDL Bounds cointegration technique to investigate the dynamic inter-linkage between foreign aid and economic growth in Sri Lanka.