Determinants of Current Account Deficits in Sierra Leone: The Bound Testing Approach

Abstract

This paper investigates the determinants of current account deficit in Sierra Leone, within the framework of the Auto Regressive Distributed Lag (ARDL) bound testing approach with annual time series data from 1980 to 2020. The unit root results reveal that the variables constitute both I(0) and I(1) series, while the bound test confirms the existence of cointegration. The results confirm that budget deficit, external debt and real exchange rate are the main drivers of current account deficit in the long run. Intuitively, the result reveals that budget deficit is positively associated with current account deficit, which confirms the validity of the twin deficit hypothesis. The result also suggests a positive relationship between external debt and current account deficit, denoting that the accumulation of debt leads to a worsening of the current account deficit. The findings also indicate a positive relationship between real exchange rate and current account deficit. This result is consistent with the Mundell-Flemming model, which predicts that an appreciation in the real exchange rate can adversely affect a country’s competitiveness position, leading to a worsening of the current account deficit. The short run result indicates that any disequilibrium in the model is corrected at the 65% adjustment speed annually. Also, the finding shows that, the coefficient of lagged current account deficit and budget deficit are the main determinants of current account deficit. The diagnostic result suggests that the explanatory variables account for 73% of the variations in current account deficit. Thus, the government should broaden the tax base and reinforce the implementation of an efficient tax administration system that could tackle tax evasion and tax avoidance, in order to enhance domestic revenue mobilization.