Exchange Rate Pass-Through: To What Extent do Prices Change in Sri Lanka?

This paper examines exchange rate pass-through into prices in Sri Lanka. The relevance of the study lies in the fact that domestic price changes due to changes in the exchange rate could be significant in monetary policy decision making. Pass-through is estimated taking two approaches. First, pass-through into import prices is estimated with the use of a log-linear regression model. The results obtained suggest that exchange rate pass-through into import prices is around fifty per cent, that is, import prices increase by about 0.5 per cent as a result of a 1 per cent depreciation of the nominal effective exchange rate. Second, taking a vector autoregressive approach, exchange rate pass-through into a set of prices in the "pricing chain" is estimated. Namely, exchange rate pass-through to factor input prices, trade prices, wholesale producer prices and retail consumer prices, is examined, with the presumption that changes in the exchange rate are due to shocks exogenous to the model. The results obtained for this model suggest that exchange rate pass-through into consumer prices is about thirty per cent, although pass-through into wholesale producer prices was found to be complete. The findings from the second model further suggest that changes in the exchange rate could have significant implications for the trade balance. (JEL E31 E52)

DOI: 10.4038/ss.v37i1.1226

Staff Studies Volume 37 Numbers 1& 2 2007 p.49-67