The twin deficits hypothesis in the SAARC countries: an empirical investigation

Abstract

Twin deficits hypothesis postulates that there is a strong positive linear relationship between a country's budget deficit and its current account deficit. This paper empirically investigates the existence of this relationship in five South Asian Association for Regional Cooperation (SAARC) countries using time-series data for the period 1980–2012. The paper uses cointegration analysis, error correction modeling and Granger causality test under a vector autoregression framework. The results show that the direction of causality for the SAARC countries is mixed. The findings confirm that budget deficit causes current account deficit for Pakistan and Sri Lanka, whereas the reverse is true for India and Nepal. The direction of causality is found to be unidirectional from current account deficit to budget deficit in the short run for Bangladesh.

Keywords:

• budget deficit
• current account deficit
• SAARC
• error correction
• granger causality
• vector autoregression

JEL Classification:

• H62
• H6
• F32

Acknowledgements

The authors are grateful to the anonymous referees of the journal for interesting comments.

Disclosure statement

No potential conflict of interest was reported by the authors.

Additional information

Notes on contributors

Navaratnam Ravinthirakumaran

Navaratnam Ravinthirakumaran is a senior lecturer in the Department of Economics, University of Colombo. Currently, he is a visiting academic in the Economics and Business Statistics Discipline, Griffith Business School, Griffith University. His research interests include political economy, economic development and poverty and ethnic studies. His publications have appeared in journals such as Sri Lanka Economic Journal and South Asia Economic Journal.

Saroja Selvanathan

Saroja Selvanathan is a professor of Econometrics in the Economics and Business Statistics Discipline at Griffith University. Her research interests include time-series analysis, econometric modeling and consumer demand. She has published in the broad area of applied econometrics and her publications have appeared in journals such as Review of Economics and Statistics, Economics Letters, Economic Record, Tourism Analysis and Applied Economics.

Eliyathamby A. Selvanathan

Eliyathamby A (Selva) Selvanathan is a professor of Econometrics in the Economics and Business Statistics Discipline at Griffith University. His research interests include applied econometrics, time-series modeling, consumer demand models and stochastic index numbers. His publications have appeared in journals such as Review of Economics Studies, Journal of Econometrics, Review of Economics and Statistics, Journal of Business and Economics Statistics, Economics Letters and World Economy and Applied Economics.