Revisiting the Twin Deficit Hypothesis in South Asia: Investigating the Role of the Crowding-Out Effect and Capital Flow Dynamics

Revisiting the Twin Deficit Hypothesis in South Asia: Investigating the Role of the Crowding-Out Effect and Capital Flow Dynamics | Research Square window.SnipcartSettings = { analytics: { enabled: false } }; (function() { var accessVector = localStorage.getItem('access_vector') || ''; window.dataLayer = window.dataLayer || []; if (accessVector) { window.dataLayer.push({ user: { profile: { profileInfo: { snid: accessVector } } } }); } })(); (function(w,d,s,l,i){w[l]=w[l]||[];w[l].push({'gtm.start':new Date().getTime(),event:'gtm.js'});var f=d.getElementsByTagName(s)[0],j=d.createElement(s),dl=l!='dataLayer'?'&l='+l:'';j.async=true;j.src='https://www.googletagmanager.com/gtm.js?id='+i+dl;f.parentNode.insertBefore(j,f);})(window,document,'script','dataLayer','GTM-K279D39R'); Browse Preprints In Review Journals COVID-19 Preprints AJE Video Bytes Research Tools Research Promotion AJE Professional Editing AJE Rubriq About Preprint Platform In Review Editorial Policies Our Team Advisory Board Help Center Sign In Submit a Preprint Cite Share Download PDF Short Report Revisiting the Twin Deficit Hypothesis in South Asia: Investigating the Role of the Crowding-Out Effect and Capital Flow Dynamics Md. Rony Masud, Mafiz Rahman This is a preprint; it has not been peer reviewed by a journal. https://doi.org/ 10.21203/rs.3.rs-7488478/v1 This work is licensed under a CC BY 4.0 License Status: Posted Version 1 posted You are reading this latest preprint version Abstract Despite extensive research on the Twin Deficit Hypothesis (TDH), its relevance to South Asia remains underexplored. This study examines the fiscal-external balance nexus in eight South Asian economies from 1990–2024, with particular attention to the moderating roles of capital flows and global crises. It addresses two key questions: how remittances and foreign direct investment (FDI) shape the transmission of fiscal deficits to current account balances, and whether crises intensify this linkage. Three hypotheses are tested: (H₁) fiscal deficits worsen current accounts, (H₂) remittances provide stronger mitigation than FDI, and (H₃) debt-vulnerable economies face amplified effects during crises, especially post-2008. Using panel ARDL and Driscoll-Kraay estimators, the results reveal three main insights. First, remittances consistently stabilize current accounts, with a 1% of GDP increase improving balances by 0.25–1.31 percentage points, regardless of fiscal stance. Second, fiscal deficits significantly worsen external balances only under crisis conditions, with COVID-19 amplifying the fiscal effect by 37%, indicating a nonlinear, crisis-contingent TDH. Third, while FDI inflows initially strain current accounts through import-intensive investments, this effect neutralizes over time. These findings challenge Ricardian equivalence in South Asia and highlight the importance of strengthening remittance channels, screening FDI for export linkages, and adopting crisis-responsive fiscal frameworks. Twin deficit hypothesis South Asia Panel ARDL remittance and FDI Full Text Additional Declarations No competing interests reported. Tables are available in the Supplementary Files section. Supplementary Files 5.Table.docx Cite Share Download PDF Status: Posted Version 1 posted You are reading this latest preprint version Research Square lets you share your work early, gain feedback from the community, and start making changes to your manuscript prior to peer review in a journal. As a division of Research Square Company, we’re committed to making research communication faster, fairer, and more useful. We do this by developing innovative software and high quality services for the global research community. Our growing team is made up of researchers and industry professionals working together to solve the most critical problems facing scientific publishing. Also discoverable on Platform About Our Team In Review Editorial Policies Advisory Board Help Center Resources Author Services Accessibility API Access RSS feed Manage Cookie Preferences © Research Square 2026 | ISSN 2693-5015 (online) Privacy Policy Terms of Service Do Not Sell My Personal Information {"props":{"pageProps":{"initialData":{"identity":"rs-7488478","acceptedTermsAndConditions":true,"allowDirectSubmit":true,"archivedVersions":[],"articleType":"Short Report","associatedPublications":[],"authors":[{"id":511787294,"identity":"6acdf1f9-2c9f-405b-9d0d-844ee2646586","order_by":0,"name":"Md. 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This study examines the fiscal-external balance nexus in eight South Asian economies from 1990\u0026ndash;2024, with particular attention to the moderating roles of capital flows and global crises. It addresses two key questions: how remittances and foreign direct investment (FDI) shape the transmission of fiscal deficits to current account balances, and whether crises intensify this linkage. Three hypotheses are tested: (H₁) fiscal deficits worsen current accounts, (H₂) remittances provide stronger mitigation than FDI, and (H₃) debt-vulnerable economies face amplified effects during crises, especially post-2008. Using panel ARDL and Driscoll-Kraay estimators, the results reveal three main insights. First, remittances consistently stabilize current accounts, with a 1% of GDP increase improving balances by 0.25\u0026ndash;1.31 percentage points, regardless of fiscal stance. Second, fiscal deficits significantly worsen external balances only under crisis conditions, with COVID-19 amplifying the fiscal effect by 37%, indicating a nonlinear, crisis-contingent TDH. Third, while FDI inflows initially strain current accounts through import-intensive investments, this effect neutralizes over time. 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