The Sri Lankan Rupee and Purchasing Power Parity during the Current Floating Period
This paper examines the empirical validity of purchasing power parity (PPP) hypothesis in a Sri Lankan context using exchange rates for six foreign currencies during the period January 1986 to November 2000. Both graphical and econometric methods are used in the analysis. Graphical analysis indicates that the spot exchange rates for the currencies except for the Indian rupee follow the respective PPP exchange rates closely during certain time periods only and real exchange rates are non-stationary thus violating a necessary condition for the PPP to hold. The results of econometric methods are also consistent with those of the graphical methods. In addition, the symmetry and proportionality hypotheses implied by the PPP were rejected. These results refute the validity of PPP hypothesis to Sri Lanka. While these results have implications for policy makers, they may be corroborated using other econometric techniques such as cointegration and error-correction models and nonlinear models.
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