Foreign Aid and Economic Growth in Sri Lanka: Implications for Developing Countries

Abstract

This study investigates the role of foreign aid in shaping Sri Lanka’s economic growth from 1980 to 2023, using Official Development Assistance (ODA) as the primary measure of external inflows. Drawing on annual time-series data from reliable international sources, the research employs a comprehensive econometric framework to analyze both short-run and long-run interactions between foreign aid and economic performance. Stationarity is verified through Augmented Dickey–Fuller (ADF) tests, while long-run relationships are examined using the Johansen cointegration approach. Fully Modified Ordinary Least Squares (FMOLS) provides unbiased long-run estimates, accounting for endogeneity and serial correlation, and a Vector Error Correction Model (VECM) captures short-run adjustments and convergence toward long-run equilibrium. Granger causality tests further identify the directionality of relationships between aid and growth. Diagnostic checks, including Breusch–Godfrey, White, Jarque–Bera, and VIF confirm model robustness and reliability. Findings reveal that foreign aid significantly enhances short-term economic performance, particularly during post-conflict recovery, disaster response, and periods of macroeconomic instability, while its long-term effectiveness depends critically on governance quality, institutional capacity, and efficient allocation. These results highlight the importance of sound aid management and policy coherence in leveraging foreign assistance to achieve sustainable and inclusive growth, offering lessons relevant to other developing countries facing similar challenges.