The impact of public debt on domestic and foreign direct investments in developing market: An ARDL bounds testing approach

Abstract

This research investigates the effect of the components of state government debts (domestic and external debts) on the various forms of investment (domestic investment and foreign direct investment — FDI) in Sri Lanka both in the short and long terms applying the ARDL bounds testing approach over the period, 1980–2020. The previous research has revealed that higher internal and external government borrowing lowers domestic investments in both the short and long terms, confirming the crowding-out effect of public debt on the volume of domestic investment of our country. The research discovered that internal debt accumulates FDI inflows in the short term, but it crowds out FDI when considering the long term. In contrast, foreign debt has a substantial inverse connection with FDI inflows in the short term, as expected, but it does not influence FDI in the long run. The findings also showed that higher lending rates of interest share a considerably inverted connection with domestic investments, but it does not have any impact on the long-term FDIs. However, in the short term, an increase in the rate of lending interest rate decreases the prospect of external financiers and crowds out the course of FDI in Sri Lanka. Further, the depreciation of the exchange rate decreases both domestic investment and the flow of FDI in the short-run, but it encourages both types of investments in the long run