Domestic financial development and external financial openness in Sri Lanka: assessing the case for greater external liberalization

This thesis explored two key aspects of growth, namely the role of financial development and external financial liberalization. In the case of financial development, it evaluated in chapter 4, how far the financial reforms implemented since 1977 was successful in increasing the level of savings and investment as postulated in the McKinnon -Shaw hypothesis. It employed an Autoregressive Distributed Lag approach (ARDL) to evaluate the impact of the interest rates on savings as well as on investment. In the case of savings, the modelling involved an unrestricted error correction model (ECM), a long-run level model and a short- run restricted ECM. To assess the impact of interest rates and savings on investment, a long-run differenced ARDL model was performed. Our empirical research confirmed that there was a positive effect from financial liberalization, both on savings and investment. In the case of external financial liberalization, it investigated in chapter 5, the contribution of outward looking policies on per capita economic growth. We employed a multiple linear regression model using OLS approach and regressed the per capita economic growth, as a dependent variable on some key explanatory variables including FDI inflows, bank credit to private sector and trade openness. We found evidence in support of our hypothesis that outward-oriented policies stood favourably in contributing for economic growth. We finally examined in chapter 6, further scope for greater external openness to contribute towards faster economic growth and development of Sri Lanka's economy. Our conclusion in this respect is that unless Sri Lanka adapts several policy measures to streamline its macroeconomic environment and gradually build up adequate external reserves, it would not be desirable for the country to consider rapid opening up of its capital account in the current setting. The overall finding of this study is that there was a positive impact of financial liberalization on savings and investment, as well as of external openness on economic growth.