The Impact of Imports on Inflation in Sri Lanka

Abstract

The objective of this study is to examine the impact of imports on inflation in Sri Lanka using annual time series data from the period 1977 to 2017. The model estimated used inflation as a dependent variable, while imports, real gross domestic product, broad money supply (M2), exports and exchange rate as the explanatory variables. To test stationary, the Augmented Dickey Fuller Test was used. In addition to that, Long-run and short-run elasticity of the variables were examined using the Autoregressive Distributed Lag (ARDL) bounds test co-integration method proposed by Pesaran et al. (2001). An error correction modeling approach was applied to the double log functional form in order to investigate the significance and effect of Supply side and demand side inflationary factors to inflation in Sri Lanka. The unit root test results indicate that inflation and exchange rate are stationary at level [I(0)] but imports, real gross domestic product, exports, exchange rate and broad money supply have a unit root problem. But, when these variables are tested at first difference the problem of the unit root has disappeared and hence it has become stationary at first difference [I(1)]. The results of the ARDL bounds F test indicate that there is a long-run relationship among the variables. According to the results of ARDL in long-run, inflation rises up by 4.64% for every one percent increase in imports. The findings of this study confirm that imports have a positive impact on inflation in Sri Lanka and the impact is significant at 1% level.