Testing the Validity of the Triple Deficit Hypothesis in the Presence of Trade Liberalization: Evidence from Sri Lanka

Sri Lanka is a classic twin deficits economy characterised by fiscal dominance - high deficits and public debt. This has manifested in a high degree of macroeconomic volatility, evidenced by its frequent balance-of-payments crises and instability. This study assesses the validity of the triple deficit hypothesis in Sri Lanka in the presence of trade liberalisation by investigating the causal association between fiscal deficit, current account deficit, and financial account deficit with a four-variate ARDL framework with Granger causality test for the period 1970-2020. The empirical findings imply that the triple deficit has widened with trade liberalisation. The output of the ARDL bound cointegrating test suggests that there is a long-run relationship between the selected variables, whilst the Granger causality test demonstrates that bidirectional causal associations exist between financial account deficit and fiscal deficit and one-way causal relationships run from fiscal deficit to current account deficit and from financial account deficit to current account deficit.