The Exchange Rate and Sri Lanka¡¯s Trade Deficit

This paper examines the responsiveness of Sri Lanka¡¯s trade deficit to devaluation during the post 1977 period. The results show that notwithstanding persistent devaluation the trade deficit continued to move in the wrong direction suggesting that exchange rate policy was unable to create a favorable balance of trade position. Individual trade volumes also were not responsive to the changes in real exchange rates. While the increase in Sri Lanka¡¯s imports has a positive correlation with the rise in domestic income the growth in its exports is positively correlated with the rise in incomes in importing countries.