The Impact of Real Exchange Rate and its Misalignment on Export Performance in Sri Lanka

Abstract

This paper examines Real Exchange Rate (RER) misalignment and its impact on export performance of Sri Lanka using quarterly data from 2001 to 2016. The results suggest that the RER in Sri Lanka was misaligned in a wide range during this period, with the range narrowing to less than +/-7 per cent in recent years. Export functions estimated against several variables including RER and its divergence from equilibrium, separately for three main categories of exports -total exports, industrial exports and textile and garments exports -suggest that that RER undervaluation does not have a statistically significant impact on any of these export categories in the long run. However, there is evidence that the RER is a statistically significant determinant of exports in the short run. In the long run, the production capacity has been identified as the major determinant of industrial exports while the trading partner's income plays a significant role in the case of textile and garment exports. This leads to the conclusion that any policy direction pertaining to addressing the long run growth of exports needs to be associated with enhancement of production capacity though short run impulsion could be provided through RER undervaluation K