Impact of fiscal and macroeconomic imbalances on economic growth: A context of regulation

Abstract

Promoting sound fiscal policies and sustainable economic growth is a global priority, including in Nepal. This study analyzes the effect of fiscal and macroeconomic imbalances on the Nepalese economy from 2006–2007 to 2020–2021. Utilizing time series data, the study examines the relationship between gross domestic product (GDP), budget deficit, trade deficit, and foreign direct investment (FDI). The augmented Dickey-Fuller (ADF) test confirms variables’ stationarity at the first difference, with long-term relationships analyzed through the Johansen cointegration test (JCT) and short-term changes captured by the error correction model (ECM). Short-term economic growth (i.e., GDP) exhibits a negative correlation with the budget deficit and a positive correlation with the trade deficit and FDI, though not statistically significant (p > 0.05). However, these variables are cointegrated in the long run, emphasizing their interconnectedness and potential linear combination. The error correcting term (-0.034) indicates a convergence speed of 3.4 percent towards long-term equilibrium. Additionally, diagnostic tests confirm the stability of coefficients in the employed models. The results align with Ahmad et al. (2013) in Pakistan but contrast with Aung (2017) in Myanmar, suggesting that while a trade deficit may stimulate short-term growth, its prolonged existence could potentially harm the nation’s economic growth in the long term.