Fiscal regimes and fiscal sustainability in Sri Lanka

Chew Lian Chua, Nelson Perera and Sandy Suardi

Applied Economics, 2021, vol. 53, issue 21, 2384-2397

Abstract: This paper employs the regime-switching model-based fiscal sustainability test which relaxes the linear fiscal reaction function approach. There is evidence of a regime-switching fiscal rule in Sri Lanka for the period 1961–2017. Non-sustainable fiscal regime is identified only in two periods – 1978-1983 and 1986-1990 – while the other periods are defined by sustainable regimes. By considering the regime-specific feedback coefficients of the fiscal policy rule and the average durations of fiscal regimes, we find that Sri Lanka’s fiscal policy satisfies the No-Ponzi game condition. Nevertheless, the country’s long-term fiscal sustainability is in question given that the stricter debt-stabilizing condition is violated. Our results pose concerns for the credibility of adopting an inflation targeting framework in the absence of long-term fiscal sustainability.

Date: 2021
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DOI: 10.1080/00036846.2020.1859456

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