Page 17 - 2022 Abstract Book RUICHSS_2022_11_17 after conference

University of Ruhuna ISSN: 2706-0063
Matara, Sri Lanka

Nonetheless, the Fed raising the interest rate to curb the elevated domestic
inflation in the US has had sweeping implications across Asia and the globe. High
external borrowing costs, persistently high inflation, and volatile commodities
markets are just a few of the threats that these countries must contend with. Similarly,
Sri Lanka is also confronted with heightened uncertainty regarding the global
economy and policy tightening in advanced economies.

First, the rising interest rate may hinder Sri Lanka's recovery from the
pandemic by reducing global liquidity. The international liquidity in Sri Lanka in
terms of the total reserves (excluding Gold), plunged by 21.59% from 2020 Q1 –
2022Q2, although the real GDP of the economy improved by 7.99%.

Nevertheless, businesses may experience a tighter credit environment paying
more to borrow money, which cuts into their profits and discourages them from
investing. Consumers are less likely to make large purchases when interest rates go
up, especially on durable goods and services. As a result, export- and manufacturing-
dependent economies like Sri Lanka will feel the effects of a decline in global demand
and growth. Increasingly stringent financial constraints, weakening fundamentals,
and significant susceptibility to commodity price volatility have all contributed to
deterioration in the state of Sri Lanka, especially for a smaller developing economy.

Because of the United States’ ever-increasing influence over Asia, investors
have pulled money out of the region's economies in response to recent monetary
tightening, leading to a depreciation of the regional currencies. Investors have
become more risk apprehensive due to rising economic and policy uncertainty, which
puts pressure on global markets. As monetary policy has tightened, the economic
outlook has worsened, recession fears have intensified, and the value of financial
assets has declined. Borrowing costs for many governments and firms have reached
their highest levels in a decade or more as bond yields have risen across the board.

Sharp currency depreciation further increased the inflationary pressures
through higher import prices of food, worsening of commodity prices and oil prices,
and worsening of the current account balance. In Sri Lanka, the inflation rose sharply
by 29.96% from 2020Q1 to 2022Q2, followed by a worsening trade balance of
38.25% from 2021Q2-2022Q2. Recently, Sri Lanka experienced an all-time high
inflation hike of 69.60$ in September of 2022. This may indicate that Sri Lanka is
experiencing a hike in imported goods prices, thus exacerbating the domestic prices
in the economy. Furthermore, with these sudden hikes in domestic prices, household
consumption in Sri Lanka drastically dropped by 9.34% from 2020Q1 to 2022Q2.

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