Exchange rate movements' effect on Sri Lanka‐China trade

Publication Date05 October 2010
AuthorKanchana Senanayake Amarasingha Appuhamilage,Ahmed Abdulhusain Ali Alhayky
Journal of Chinese Economic and
Foreign Trade Studies
Vol. 3 No. 3, 2010
pp. 254-267
#Emerald Group Publishing Limited
DOI 10.1108/17544401011084325
Exchange rate movements’ effect
on Sri Lanka-China trade
Kanchana Senanayake Amarasingha Appuhamilage
Lanka Mirigama Special Economic Zone (Private) Limited –
China Huichen Investment, Colombo, Sri Lanka, and
Ahmed Abdulhusain Ali Alhayky
Shanghai University of Finance and Economics, Shanghai, China
Purpose – The purpose of this paper is to examine empirically the effects of exchange rate
movements on trade performance with reference to the Sri Lanka-China trade relationship over the
quarterly period from 1993 to 2007.
Design/methodology/approach – This paper tests this condition for the trade between Sri Lanka
and China in two steps. First, it investigates the exchange rate movements on Sri Lanka’s aggregate
exports and imports between China using selected variables such as the real bilateral exchange rate
change, the change in income and the exchange rate volatility. Second, this study constructs a panel
regression model using Sri Lanka’s sectoral exports and imports between China and tests whether
exchange rate movements have detrimental effects on sectoral trade.
Findings – The main finding is that bilateral exchange rate changes and exchange rate volatility do
play an active role on trade, while income growth changes have less influence in determining the total
exports and imports between two countries. The analysis of data shows that chan ges in real bilateral
exchange rate, income and exchange rate volatility are playing a major role in determining sectoral
exports and imports between Sri Lanka and China. Therefore, the findings suggest that the
movements of exchange rate between these two countries do have significant effects on total trade as
well as sectoral trade between Sri Lanka and China.
Keywords Exchange rates, Trade, Exports, Imports, China, Sri Lanka
Paper type Research paper
1. Introduction
Despite substantial empirical research, the effects of exchange rate movements on the
trade flows are still not well understood. Neither theoretical nor empirical work has
established definitively whether a devaluation of a country’s domestic currency
improves its trade performances, or even if exc hange rates movements play a role in
determining international trade flows.
The exchange rate system of Sri Lanka hasevolved from a regime offixed exchange
rates to a managedfloat and finallyto an independent float. SriLanka underwent a major
reform on exchange rate system in 1977 and introduced the managed floating exchange
rate system. Until that time, exchange rate had been determined by way of pegging the
rupee to a single currency or a composite of cur rencies.The r upee came under increasing
pressure in mid-2000 when there was serious decline in Sri Lanka’s external reserves. As
a result of these problems theCentral Bank stopped announcing buying andselling rates
in advanceand a free float exchange rate regimewas introduced in 2001.
Following the exchange rate movements how does revaluation/devaluation affect
the current account? A common question in the field of international eco nomics is the
determination of circumstances under which exchange-rate movements improve
the external trade balance. A traditional answer to this question is that it is defined by
the Marshall-Lerner condition.
However, along with the rapid increase in Sri Lanka-China trade in the last few
decades, Sri Lanka and Chinabec ame large trade partners for each other.An early and
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