• pISSN 2523-2614, eISSN 2663-693X
  • Annual Publication Open Access
  • Current Issue

A cointegration analysis between macroeconomic variables and fiscal deficit in Pakistan

  • 2018 | Volume: 2 | Issue: 1 | Page: 33-40


This paper estimates the short and long run association between selected macroeconomic variables and fiscal deficit in Pakistan for the period of 1985 to 2016. Macroeconomic variables such as exports, exchange rate, GDP per capita, inflation, gross capital formation have strong implications for the fiscal deficit. This study checks the data for stationarity using the Augmented Dickey Fuller test. Johansen Co-integration test and Vector Error Correction Method are used to investigate both the short and long run relationships. Results indicated the existence of both short run and long run relationship between the macroeconomic variables and fiscal deficit. The findings of the study revealed that exports, exchange rate, GDP per capita, inflation, gross capital formation are important determinants of fiscal deficit in Pakistan. The study suggested that the government may focus on these factors to overcome fiscal deficit in Pakistan.

Keywords and JEL Classification


Fiscal Deficit, Johansen Cointegration test, Vector Error Correction Method

JEL Classification

B22, E6, E62, E63, F62

1. Introduction

2. Literature Review

   Agha & Khan (2006) investigated the long run association between inflation and fiscal deficit in Pakistan using monthly time series data from 1973-2003. They used Johansen co-integration test and vector error correction models (VECM) for testing the relationship. They found that inflation was associated with fiscal deficit in the long run. Also, the VECM model indicated that inflation is affected by the public’s borrowings from banks when fiscal deficit is financed. Epaphra (2017) found that the exchange rate and real GDP had a negative role on budget deficit while budget deficit was positively related to money supply, inflation and interest rate in Tanzania. Usman and Adebisi (2017) also investigated the factors responsible for widening the gap between Nigerian's government revenue and expenditures.

   Uppal (2011) stated that Pakistan’s political process, institutional condition, and budget processes influences the fiscal budget and that the fiscal deficit can be improved by introducing better discipline, institutional checks & balances and better market discipline. Better governance and development of political institutions can play a long-term improvement in the fiscal deficit. Furthermore, Javid et al. (2011) studied the budget deficit of South Asia and ASEAN countries using the dynamic panel method. They found that high inflation and high budget to GDP ratio had a positive effect on budget deficit whereas better political situation, growth and social development negative effect on deficits. Furthermore, it is also found that corruption and mismanagement were contributing to high budget deficit.

   Anwar & Ahmad (2012) examined the short and long run association between deficit and factors such as democracy, economic growth of Pakistan. They found that government size had positive impact on the budget deficit. Furthermore, democracy was not found to have any impact on the budget deficit of Pakistan. Also, Brima and Pearce (2015) investigated the association of financial deficit with selected macroeconomic variables using Johansen’s test of co-integration, vector error correction model and the Granger causality in Sierra Leone for the period from 1980 to 2014. They found that exchange rate, GDP and supply of money had an inverse association with the deficit while interest rate and inflation had a positive relationship with the budget deficit.

   Torayeh (2015) employing the auto-regressive distributed lag (ARDL) estimated the factors for deficit in Egypt using time series data from 1985 to 2013. They found that the interest payments and people income increase the Egypt deficits. Further, these payments eats away a big chunk of the tax revenues. They suggested that subsidies and interest payments may be curtailed to control the budget deficit. Further, tax reforms are also needed to improve the revenue. Safdar and Padda (2017) also investigated the impact of institutional quality on budget deficit utilizing time series data from 1984 to 2014. They found that weak institutions cause high budget deficit due to mismanagement and leakages in the economy. Further, they discovered that open trade and inflation had a positive effect on the financial deficit. Real gross domestic product per capita was not found to have a significant effect on budget deficit. Mismanagement, fraud, corruption, weak rules and regulation also cause the deficit. They suggested that policymakers should pay attention to improve institution's quality to improve the budget deficit.

3. Research Methods

4. Results & Discussion

5. Conclusion

   The study analyzed the short and long-run relationship between selected macroeconomic variables namely exports, GDP per capita, exchange rate, inflation, gross capital formation and fiscal deficit for Pakistan over the period 1985 to 2016. Augmented Dickey-Fuller (ADF) test was applied to the data for checking the stationarity in data. The ADF the results showed that all the variables were stationary at first difference. Knowing the data was stationary at I(1), Johansen Co-integration test and Vector Error Correction Method were used for investigation the long run relationship between dependent and independent variables. Finally, the existence of short-run relationship was checked by using the Wald test. The results showed that exports, exchange rate, GDP per capita, inflation, gross capital formation are the most important determinant of fiscal deficit in Pakistan. This study concluded that Exports, GDP per capita and inflation has a high impact on fiscal deficit in Pakistan.


Agenor, R, P., & Montiel, J. P. (1999), Development macro-economics, Princeton University Press, 2nd edition.

Agha, A. I., & Khan, M. S. (2006). An empirical analysis of fiscal imbalances and inflation in Pakistan. SBP Research Bulletin2(2).

Anwar, M., & Ahmad, M. (2012). Political determinants of budget deficit in Pakistan: An empirical investigation (No. 135). HWWI Research Paper.

Brima, S., & Pearce, E. (2015). Budget deficit and macroeconomic variables in Sierra leone: an econometric approach. Journal of Economics and Sustainable Development, 6(4)

Chaudhary, M. A.,&Abe, K. (1999), Pakistan econo-my: Current situation and future prospects. Chiba University Economic Journal, 14(1),49-85.

Epaphra, M. (2017). Analysis of budget deficits and macroeconomic fundamentals: A VAR-VECM approach. Journal of Economics & Management, 30, 0-57

Government of Pakistan (2016/2017). Pakistan Economic Survey http://www.finance.gov.pk

Jagirani, T., Abro, k., &Tahir, H. (2016). A vector error correction model (VECM):An approach to short-run and long-run causality between solvency and liquidity: a study of oil & gas development company limited (OGDCL), Pakistan. International Journal of Management Sciences and Business Research, 5(4).

Javid, A., Arif, U., &Arif, A. (2011). Economic, political and institutional determinants of budget deficits volatility in selected Asian countries. The Pakistan Development Review 50(4), 649–662.

Juseoff, K., Shamsudin, N., Mohamad, Z., Jusoh. N., Baharuddin, N. S., &Asari, H. (2011), A vector error correction model (VECM) approach in explaining the relationship between interest rate and inflation towards exchange rate volatility in Malaysia, World Applied Sciences Journal, 49-56.

Peacock, A. T. (1961). and J. Wiseman. The Growth of Public Expenditure in the United Kingdom.

Romer, C. (1986). Spurious volatility in historical unemployment data. Journal of Political Economy, 94(1), 1-37.

Safdar, F., & Padda,I. (2017). Impact of institutions on budget deficit: the case of Pakistan. NUML International Journal of Business & Management. 12(1),2410-5392.

Citing Articles (0)

Article Metrics
Citation Indexes