Foreign direct investment, trade openness, and financial development as drivers of economic growth: evidence from Sri Lanka
Tharsika KrishnasamyPurpose
This study examines the short- and long-run relationships between foreign direct investment (FDI), trade openness, financial development, and economic growth (GDP) in Sri Lanka. It aims to clarify how these variables interact to inform sustainable growth policies.
Design/methodology/approach
The study employs annual time series data for Sri Lanka spanning 1970–2024. The variables include GDP (annual growth rate of real GDP), FDI (net inflows in current US$ million), Trade Openness (total trade as a percentage of GDP), and Financial Development (domestic credit to the private sector as a percentage of GDP). The study applies the Autoregressive Distributed Lag (ARDL) bounds testing approach and Error Correction Model (ECM) to analyze both short-run dynamics and long-run equilibrium relationships. The optimal model, selected by the Akaike Information Criterion, is ARDL (1, 4, 0, 0).
Findings
Results confirm a long-run cointegrating relationship among the variables. In the long run, FDI, trade openness, and financial development are statistically insignificant, while in the short run, FDI has a strong positive effect on GDP.
Practical implications
FDI stimulates short-term growth, but long-run development requires structural reforms, institutional strengthening, and improved financial market efficiency. Trade policies should be paired with infrastructure and export diversification to maximize growth benefits.
Originality/value
This study offers new evidence on the dynamic linkages among FDI, trade openness, and financial development in Sri Lanka, incorporating recent economic disruptions and using robust ARDL–ECM methods to ensure reliable policy insights.