Symmetric or Asymmetric: How do Sri Lanka’s Bilateral Trade Balances Respond to Real Exchange Rate Changes?

This paper examines the impact of real exchange rate fluctuations on the trade balance between Sri Lanka and its major trading partners using the Non-linear Auto Regressive Distributed Lag model. Analysing data from the first quarter of 2007 to the fourth quarter of 2022, covering 10 trading partners, the study reveals varied reactions in the trade balance to real exchange rate depreciation versus appreciation, supporting an asymmetric effect. While some results align with conventional exchange rate theory, showing a positive long run effect of real depreciation, others indicate only a short run effect. The mixed empirical findings underscore the lack of uniformity in the relationship between real exchange rates and trade balances, which can be attributed to differences in the composition of traded goods. Given these asymmetries, it is evident that exchange rate policy alone has limited capacity to enhance the overall trade balance of the country. Therefore, adopting a comprehensive policy package to ensure Sri Lanka’s global competitiveness is imperative to effectively address the multifaceted nature of trade dynamics.