Introduction
The exchange rate can be defined as the rate at which currency of one country exchanges
for a currency of another country. Simply, it is the price of one currency in terms of another
currency. For a small economy like Sri Lanka, the exchange rate is very important because it
affects the prices of exports and imports. Also, the currency depreciation happening in the
country creates several impacts on the economy. Therefore, the government should manage
the exchange rate in accordance with the economic situation of the country. Within the 6
decades after gaining political independence in 1948, Sri Lanka’s exchange rate system
has evolved from a fixed exchange rate regime to an independently floating regime with no.
of rupee depreciation. And the evolution of these exchange rate regimes including the
currency depreciation is mentioned below.
Fixed Exchange Rate Regime (1948 – 1967)
When gaining political independence in 1948, Sri Lanka had a fixed exchange rate regime
where the exchange rate was pegged to the Indian rupee. Although Sri Lanka rupee (Ceylon
rupee) was introduced as the standard unit of value in 1941 by the Currency Ordinance of
1941 its value was linked to the Indian rupee. At that period, the Indian rupee was linked to
the pound sterling like most of the colonial countries. Therefore, Sri Lanka rupee also
indirectly related to the pound sterling. During that period, the center of the banking and
financial system of the country was known as the Currency Board, and it had the sole
authority to issue and manage the currency within the state. A 100% foreign reserve was
maintained for the backing of the money.
On September 19, 1949, the pound sterling was devalued by 30.52% (exchange rate of the pound
sterling against the US dollar was changed from $ 4.03 to $ 2.80). Accordingly, India also
devalued its currency by the same proportion to maintain the same exchange rate
relationship with the pound sterling. As a result of that, the value of the Sri Lanka rupee was
devalued by the same proportion due to the linkage with the Indian rupee. In 1949, there was a
surplus of Rs.37 million in the trade balance of Sri Lanka. Although this amount was small
compared to the trade balance of Rs.94 million in 1948, it was a positive balance. Therefore,
this had a minor effect on the devaluation decision of Sri Lanka rupee. According to Ivor
Jennings, Britain was one of the best customers of Sri Lanka at that period. In 1948,
exports for Britain represented 32% of total trade. So, if the rupee had not been devalued,
the main exports, which are tea, rubber and coconut would be less competitive in the world
market, and the export revenue would be decreased. Another reason for the rupee devaluation
was that the foreign assets of Sri Lanka held almost in either pound sterling or Indian rupee
during that period. Therefore, if Sri Lanka did not devalue the rupee, the value of those
assets would be decreased by the sterling devaluation percentage. (Refer to Table 1)
The Central bank of Sri Lanka was established in 1950 as a replacement for the Currency
Board. Stabilization of the domestic and external values of the rupee and promoting
economic growth are the main objectives of the establishment of the Central bank. And almost
immediately after the introduction of the Central bank, Sri Lanka joined the International
Monetary Fund (IMF). Accordingly, Sri Lanka severed the long term exchange rate link with
Indian rupee and moved into an independent exchange rate policy. However, the fixed
exchange rate system was continued, and the monetary authorities believed that the fixed
exchange rate regime was essential to improve international trade and investments.
The monetary value of rupee was fixed at 0.88 grams of gold. The exchange rate was decided
as Rs.13.33 for one pound and Rs.4.77 per one US dollar. (Refer to Table 2)
From 1957 to 1966, Sri Lanka’s balance of payments was continuously deteriorated due to
the higher import expenditure compared with the export value. (Refer to Table 3) Foreign
reserves of the Central bank also significantly decreased when it comes to the end of 1960
Decade (Ramasinghe, 2007). This situation was worsened when the pound sterling was
devalued. To maintain the export competitiveness, Sri Lanka devalued the rupee by
20% on 22 November 1967 by fixing the exchange rate at Rs.14.30 per pound sterling
(Wickramasinghe, 1985). The main intention of the Central bank behind this devaluation was
to motivate the exports and increase the competitiveness of export prices and to limit imports
to a certain extent.
Dual Exchange Rate Regime (1968 – 1977)
The balance of payments problem of the country was not entirely solved by the rupee
devaluation in 1967. Therefore, a dual or a multiple exchange rate systems were introduced in
May 6, 1968, known as the Foreign Exchange Entitlement Certificate Scheme (FEEC). The main
objective of this scheme was to diversify exports and restrain the increase in imports. There
were 2 rates involved in this scheme.
1. Official rate
2. Certificate rate/ premium rate
The official rate applied to essential imports and traditional exports. And the premium
rate applied to all other commodities and imports. At the initial stage, the official rate was
fixed at Rs.14.2857 per pound sterling, and the premium rate was set at Rs.20.5714 per pound,
which was 44% above than the official price. In 1969, this rate was increased up to 55%, and
it was increased up to 65% in 1972 (Ramasinghe, 2007).
In 1971, due to the suspension of the convertibility of the US dollar into gold, the value of the
US dollar began to depreciate against the pound sterling. In Sri Lankan point of view, this
might cause to reduce the export income coming from dollar zone countries. Also, some of
the rival states of Sri Lanka in the export market had pegged their currencies to the US
dollar. Therefore, after considering these facts, Sri Lanka decided to peg the Sri Lanka rupee
to the US dollar on November 8, 1971. Accordingly, the exchange rate was set at Rs.5.95 per
US dollar. The Sri Lanka rupee-dollar rate remained unchanged due to this linkage with the US
dollar at that time. However, Sri Lanka rupee was depreciated against other major currencies
in this year. In 1971, Sri Lanka rupee showed depreciation of 5.79% against the pound
sterling (from Rs.14.2857 to Rs.15.1649). Likewise, Sri Lanka rupee depreciated against the
Deutsche mark by 10.11%, against the French franc by 5.93%, against Japanese yen by 8.33%
and against the Indian rupee by 0.73%. (Refer to Table 4)
In 1972, the United Kingdom was decided to float the pound sterling. To avoid the unfavorable
effect on exports to the sterling area and higher prices for imports, the Central bank decided
to re-peg the Sri Lanka rupee to the pound sterling on July 10, 1972. So, the exchange rate
was fixed at Rs.15.60 per British pound. However, due to this re-peg, the Sri Lanka rupee
again depreciated in 1972 against all the major currencies. It depreciated by 6.92% against
US dollar (from Rs.5.9524 to Rs.6.3953), by 2.78% against the pound sterling, by 10.11%
against Deutsche mark, by 10.88% against French franc, by 15.49% against Japanese yen and
by 3.65% against the Indian rupee. (Refer to Table 4)
Another important event occurred in 1972 was the introduction of Convertible Rupee
Account System (CRA). Although it was not exactly an exchange rate system, it was used to
motivate the non- traditional exports. By using this system, 25% of the foreign exchange
gained by the non- traditional commodities could be deposited in a convertible rupee account in the
Central bank. And the account holders had the freedom to use the balance in their minds to
engage in foreign tours or to export or import what they like.
In 1976, the linkage of the Sri Lanka rupee with the pound sterling was terminated by the
The central bank to protect the rupee from the uncertain events of the other countries.
Instead, the exchange rate of the Sri Lanka rupee was allowed to be determined relative to an
appropriately weighted basket of currencies.
Managed Floating Regime
The dual exchange rate system was abolished in November 1977, and both rates, which are
the official rate, and the premium rate were unified at Rs.16 per US dollar. A managed
floating exchange rate regime was introduced after that, and the rupee was allowed to float
according to the demand and supply conditions in the foreign exchange market. However, the
unification of the exchange rate on November 16, 1977, resulted in a devaluation of the rupee
by 44.6% against US dollar, by 45.5% against the pound sterling and by 44.8% against the Indian
rupee (Wickramasinghe, 1985).
Economic Impacts of currency depreciation
▪ Positive impact on the trade deficit of the country
When the exchange rate depreciates, the imports become more expensive for domestic
customers as they have to pay a higher rupee amount than before. Then the demand
for imports will go down. On the other hand, exports become cheaper for foreigners
as they have to pay less amount of money than before to buy our commodities. Then the
export competitiveness of the country will be improved. Therefore, people will
demand more domestically produced goods and the foreign demand for exports will
also go up. But, in a situation where the country imports essential products, the need
for those imports will not decrease even they become expensive.
▪ Increase in the rupee value of the foreign currency debt payments of the government
and the private sector.
▪ Increase in import prices will cause the prices of imported raw materials, intermediate
goods to rise. Then the final products produced by using these inputs will have a higher
cost. This will affect the general price level to go up.
▪ Because of the increased demand for exports, export-related industries will likely to
expand, and more domestic resources will be allocated to these industries.
▪ The employment opportunities in export production industries will increase.
▪ Tourist arrivals will be increased because they can get more domestic currency units
within our country for their own group of currency.
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