The Impact of Foreign Aid on Economic Growth in Sri Lanka

Abstract

This study investigates the impact of foreign aid on Sri Lanka’s economic growth over the period 1980–2023, with a particular focus on Official Development Assistance (ODA) as the main proxy for foreign aid inflows. Despite Sri Lanka’s long history as a major recipient of bilateral and multilateral aid, its persistent macroeconomic challenges - high debt, fiscal deficits, and recurring economic crises - raise critical questions about the effectiveness of foreign aid in fostering sustainable growth. Using annual time series data from credible sources, this research applies the Autoregressive Distributed Lag (ARDL) bounds testing approach to examine both short-run and long-run relationships between ODA and GDP growth, while controlling for key macroeconomic factors such as domestic investment, inflation, trade openness, and political stability. The results reveal that foreign aid has a positive impact on short-term economic growth, particularly in times of crisis and reconstruction, but its long-term effectiveness depends heavily on the quality of governance, institutional capacity, and the strategic allocation of funds. Findings highlight that weak institutions, inefficient use of aid, and political instability can undermine the potential benefits of ODA, creating risks of aid dependency and economic distortions. By providing empirical evidence specific to Sri Lanka’s unique development context - including its post conflict recovery, natural disasters, and recent debt crisis - this study contributes to the global discourse on aid effectiveness in developing countries. It emphasizes the need for improved aid management, greater transparency, and stronger policy frameworks to ensure that foreign aid aligns with national development goals and supports inclusive, resilient growth. The study concludes with practical policy recommendations for both domestic policymakers and international donors to enhance the impact of foreign aid in Sri Lanka, thereby strengthening its contribution to long-term economic sustainability and poverty reduction.