Monetary and fiscal factors in nominal interest rate variations in Sri Lanka under a deregulated regime

Abstract

Background: This paper examines the role of monetary and fiscal factors in interest rate variations in Sri Lanka under its deregulated regime of interest rates. In addition the paper also examines the role of monetary factors in the variation of interest rates, using a quarterly dataset for the post-global recession period, when the exchange rate is determined by market forces. Results: Empirical analysis uses a dataset of nominal interest rates, money growth, income growth, changes in nominal exchange rate, and budget deficit. From the methodological point of view the paper involves vector autoregression model and Wald tests of Granger causality, followed by impulse response analysis while stationarity and the order of integration of the selected variables are confirmed involving the augmented Dickey-Fuller and the Phillips-Perron unit-root tests. Results: The paper confirms that both monetary and fiscal factors have significant effects on the variations of interest rates. Money growth triggers an increase in interest rates, which supports the Fisher equation view, while income growth has a negative impact. Budget deficit causes a rise in interest rates, but the role of the exchange rate is found to be almost insignificant, probably due to including exchange rate series that cover both the pegged and market-based regimes of exchange rates. The second part of the analysis, using a quarterly dataset for the post-global recession period, further establishes the positive impact of M2 money growth and income growth on interest rates. In this case, exchange rate depreciation causes an increase in interest rates.

Time and Frequency Dependency of Foreign Exchange Rates and Country Risk: Evidence From Turkey

“…Many researchers examine the FX rates from different perspectives in the current literature. For example, Onanuga and Shittu (2010), Maitra (2017), Obeng and Sakyi (2017), and Kartal (2020) examine the FX rates from the interest rates perspectives, while Hajilee and Al Nasser (2014), Korhonen (2015), Jebran and Iqbal (2016), Demir (2019), Kartal et al (2020), Narayan et al (2020), Depren et al (2021), and Kartal et al (2021a) examine the FX rates from stock market index perspectives, and Sujit and Kumar (2011), Wang and Chueh (2013), and Dinçer et al (2018) examines the FX rates from the gold prices. Moreover, the FX rates are examined in terms of the nexus with Credit Default Swap (CDS) spreads (Fontana and Scheicher, 2016;Hassan et al, 2017), economic policy uncertainty (Krol, 2014;Beckmann and Czudaj, 2017;Sharif et al, 2020), geopolitical risk (Iyke et al, 2022), foreign portfolio inflows (Kartal et al, 2020), monetary policy indicators like emission (Depren et al, 2021), oil prices (Kartal, 2021); sovereign credit risk (Augustin et al, 2020), and volatility (Depren et al, 2021;Devpura et al, 2021;Kartal et al, 2021a).…”

Deficits, Debt and Interest Rates in Sri Lanka: Does the Spillover of Foreign Interest Rates Matter?

“…The study also reported that liquidity preference theory and the Fisher effect are not useful in explaining short-term variations in the interest rate. On the contrary, Maitra (2017) reports that some variables of monetary policy and the budget deficit influence interest rates in Sri Lanka; this study did not explore the impact of the foreign interest rate. We could not find any other study that examined the impact of fiscal policy and external factors on interest rate variations in Sri Lanka.…”

“…To the best of our knowledge only a few studies-Peiris and Jayasinghe (2014), Maitra (2017)-have researched factors causing variations in interest rates in Sri Lanka. These studies involved selected instruments of monetary and fiscal policies as possible determinants of interest rates.…”

How do fiscal, monetary policies, and trade openness impact interest rates in India?

“…Dell'Erba and Sola (2016) have reported that the global monetary and fiscal policy stances explain more than 60 percent of the variance in the long‐term interest rates of OECD countries for the period 1989–2013, where the significance of domestic variables is weakened. Maitra (2017) confirms that both monetary and fiscal factors have significant effects on the variations of interest rates in Sri Lanka over the period 1983–2015, where budget deficit causes a rise in interest rates. Subsequently, Maitra (2019) finds that foreign debt causes a rise in the interest rate in Sri Lanka over the period 1977–2016.…”