Analysis of Factors Affecting USD/LKR Exchange Rate

Abstract

This paper intends to investigate the factors affecting the US Dollar exchange rate in Sri Lanka, in the period of January 2009 to June 2015, by using the econometric framework of Johanson and Juselius Cointegration, Vector Auto Regressive model, Granger Causality, and Variance Decomposition analysis. The empirical results of the model indicate that the increase in previous month net foreign assets and trade balance, and a decrease in the previous month exchange rate, has a significant influence on the short run appreciation of exchange rate. Granger Causality test confirms past values of net foreign assets, trade balance, and workers’ remittance have a predictive ability in determining the present values of exchange rate while, Variance Decomposition indicate, variation in exchange rate in short term and long term time horizon is due to the exchange rate itself and net foreign assets, trade balance and workers’ remittance respectively.