Exchange rates, trade liberalization and aid: The Sri Lankan experience

Abstract

In 1977 the Sri Lankan government embarked on an extensive program of liberalization, an important element of which was devaluation to ensure a competitive real exchange rate. The 1980s were, however, marked by an increasing divergence between the real and nominal exchange rates, the depreciation of the latter not being matched by similar movements of the former. This paper presents an econometric model of real exchange rate behavior in Sri Lanka. Among other things, it is shown that increased aid inflows have made a significant contribution to the failure of the real exchange rate to match the depreciation in the nominal rate.