Determinants of sovereign spreads in Sri Lanka: global factors and country-specific fundamentals

Abstract

Purpose
The study aims to analyze and compare the influence of country-specific fundamentals and global conditions on sovereign risk of Sri Lanka within the sample period of 2006–2019 while employing Treasury bond rates as proxy for sovereign risk.

Design/methodology/approach
The determinant powers of the variables are assessed using the auto regressive distributed lag (ARDL) model to verify both short- and long-run effects on sovereign spreads.

Findings
The study finds that Sri Lanka's sovereign spreads are shaped by both country fundamentals and global factors, though local determinants tend to have greater influence when the directions of coefficients are ignored. While the impact of most variables was in line with the researchers' expectations, fiscal deficit was found to have an unconventional negative coefficient which may be explained by investors' optimistic take on Government's involvement in post-war economic development drive during the sample period, enabling Sri Lanka to attract low-cost funding.

Research limitations/implications
The study excludes of impact of the ongoing coronavirus disease-2019 ( COVID-19) health crisis which may unduly distort the data. Further, the research does not capture the impact of change in sentiment owing to market information, debt dynamics and policy changes in Sri Lanka.

Practical implications
The study reveals that a sound monetary policy directed at preserving both the internal and external value of currency as well as a disciplined fiscal policy are imperative to manage Sri Lanka's sovereign risk, particularly in the face of global uncertainties.

Originality/value
The study adds to the literature by investigating the timely importance of a country's internal fundamentals against the global events. Furthermore, the research would complement the scarcity of research regarding that subject focused on the Sri Lankan economy, capturing the rapid variations in the fundamentals that the country has undergone since the end of the civil war while recognizing the growing influence of globalization over the recent years.