Abstract:
USA is the topmost export destination for Sri Lanka. USA solely provides market place for 24% of
Sri Lanka’s total exports. USA’s contribution in Sri Lankan export market is even bigger than the
combined market share of the next three top trading partners, namely; UK, Italy and India. In terms
of imports, USA stands at the 6th place sharing 2.5% of the total imports of Sri Lanka. Also, the
USA is the prime export destination of Sri Lanka’s textile and garment industry solely buying 45%
of the total exports. Sri Lanka has been maintaining a substantial trade surplus in the bilateral trade
with USA over decades. This study attempts to answer the research question whether the bilateral
exchange rate is a decisive factor determining the USA-Sri Lanka trade controlled for the other
economic fundamentals, with the objective to examine whether Sri Lanka will gain or lose by the
continuous currency depreciation in USA-Sri Lanka trade. Using quarterly data from 2004Q1 to
2019Q4, obtained from the Central Bank of Sri Lanka and IMF, the researcher estimated the
standard real export (RXP), real imports (RMP), and trade Balance (TB) functions developed by
Rose (1989) with slight modifications to include dummy variable to capture structural breaks. The
empirical results suggest that 1% increase in domestic price level causes 0.8% drop in real exports
to USA, while 1% depreciation of local currency causes to improve real exports to USA by 0.01%
in the long-run. The two conclusions drawn above are effectively endorsed by the estimated TB
function too. It suggests that 1% increase in domestic price level causes nearly 0.7% drop in bilateral
TB ratio, while 1% depreciation of local currency causes to improve TB ratio by 0.9% in the long run. Accordingly, the study concludes the depreciation of Sri Lankan rupee against US Dollar is
beneficial for Sri Lanka provided the local price level is under control.