15. The Relationship Between Macroeconomic Variables and Budget Deficit: A Comparative Study of Sri Lanka with Malaysia and South Korea

The association between budget deficit and macroeconomic variables and the repercussions for macroeconomic instability has been among the most widely debated topics 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. The explanatory macroeconomic variables are inflation, interest rates, exchange rates, debt and real GDP growth rate. A Granger Causality test was carried out to determine whether the selected variables’ impact on budget deficit was uni- or bi-directional. The comparative study considered panel analysis. Data were sourced from the IMF, World Bank and Central Bank of Sri Lanka annual reports. The Sri Lankan finding was that there was uni-directional causality between the 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 the variables. The panel analysis suggested that debt and real GDP growth rate are significant variables in controlling a budget deficit. A country’s debt level is a significant variable in controlling the size of the deficit. In Sri Lanka, it is important to consider economic policy strategies implemented by Malaysia and South Korea to mitigate prevailing economic issues of a sustained sizable budget deficit, significant debt maturities, weaker public finances and higher domestic and foreign currency debt, all of which disrupt achievement of sustained economic growth.