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The Impact of Interest Rate and Inflation Rate Towards Exchange Rate: A Case of Sri Lanka

Exchange rate can be explained as one of the key factor, which emphasis countries macro-economic stability. As an emerging market Sri Lanka is mainly focused on international markets and highly depend on international trade. This study is on the influence of interest rate (Weighted Average Call Market Rate - CR) and inflation (Colombo Consumers' Price Index (CCPI) - INF), to the exchange rate (USD/LKR - NEXR). The research analysis monthly data of CR, NEXR and CF for the period of October 2000 to March 2013 based on Vector Error Correction Model. This research uses stationary test, cointegration test, stability test, impulse response function, residual test has generated to compile and analysis data. Results of the study proves that the exchange rate has negative relationship with interest rate for the given period. However, the exchange rate shows positive relationship with inflation. Those relationships are significant in long run causality, where it takes much more time to become equilibrium position. Further, there is no short run causality as well. The negative relationship between exchange and interest rates creates a favorable environment to capital inflows to the country. However, manipulation of exchange rate volatility by the relevant market players will lead to a change in the expected relationship of the variables. According to the results, policy makers should estimate most appropriate policy interest rate level in Sri Lanka to manage sustainable growth. Further, the regulatory authorities should manage appropriate intervention mechanisms to the foreign exchange market to control exchange rate to avoid market manipulations.

Exchange Rates, Interest Rates, Inflation Rates, Vector Error Correction Model, Cointegration Test, Causality

APA Style

Morawaggoda Kankanamalage Tharaka Nayana Hansi. (2023). The Impact of Interest Rate and Inflation Rate Towards Exchange Rate: A Case of Sri Lanka. International Journal of Economic Behavior and Organization, 11(3), 107-124.

ACS Style

Morawaggoda Kankanamalage Tharaka Nayana Hansi. The Impact of Interest Rate and Inflation Rate Towards Exchange Rate: A Case of Sri Lanka. Int. J. Econ. Behav. Organ. 2023, 11(3), 107-124. doi: 10.11648/j.ijebo.20231103.11

AMA Style

Morawaggoda Kankanamalage Tharaka Nayana Hansi. The Impact of Interest Rate and Inflation Rate Towards Exchange Rate: A Case of Sri Lanka. Int J Econ Behav Organ. 2023;11(3):107-124. doi: 10.11648/j.ijebo.20231103.11

Copyright © 2023 Authors retain the copyright of this article.
This article is an open access article distributed under the Creative Commons Attribution License ( which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.

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