Fiscal vulnerability, financial stress, and macroeconomic policies in Sri Lanka

Abstract

Fiscal policies play a critical role in achieving sustainable development goals, supportingdomestic resource mobilization, and improving the effectiveness of public spending. Such policies also promote investment and facilitate fiscal reforms, aligning with SDG target 17.1, which emphasized strengthening financial options and domestic resource mobilization. Hence, fiscal risks are required to be identified in order to improve macroeconomic policies. This research was aimed at evaluating the current state of public finance in Sri Lanka to identify its structural weaknesses that led to bankruptcy, with the objective of making recommendations for economic reform through the most appropriate form of macroeconomic policy. A quantitative data analysis was adopted using statistical data for different indicators for the period 1960-2020. The study developed three indexes: fiscal vulnerability, financial stress, and macroeconomic policies, all of which were obtained based on certain indicators. For establishing the causal effect of the variables, the study used the auto regressive distributed lag (ARDL) model which allows theconsideration of long-run and short-run impacts. By using co-integration tests, the research virtually pointed to directional causality and proved the existence of long-run links between the variables. Another finding of the research was the need to adopt a capacity mechanism appropriate for Sri Lanka. Previous work insisted that there was a need for the compliance of capacity mechanisms employed by developing countries to abide by the standards set out by the International Monetary Fund (IMF). Moreover, the study focused on the practical aspects in controlling the fiscal state and called for attention on refinancing risks of public liabilities. In conclusion, the work called for a more integrated fiscal balance needed for the betterment of the macroeconomic framework in Sri Lanka needed to achieve sustainable development goals.