K. P. M. ChathurikaO. G. Dayaratna Banda2025-09-292025-09-292025-09-24Peradeniya University Research Session (PERS) -2016, University of Peradeniya, P 48 - 53https://ir.lib.pdn.ac.lk/handle/20.500.14444/5215Introduction The exchange rate has (the Sri Lankan rupees against US dollar) depreciated from 1986 to 2013 in Sri Lanka (CBSL, 2013). It means the loss of value of Sri Lankan currency with respect to US dollar. The exchange rate is affected by many components including interest rate as one of those macroeconomic variables. According to the exchange rate channel indicated in Monetary Transmission Mechanism, it can work through either net exports or import prices. Increased money supply tends to lower the interest rate leading to a depreciation of the exchange rate. The depreciation of the exchange rate also raises import prices, which directly affect the several price levels, thus creating inflation (Amarasekara, 2005). The theoretical as well as empirical relationship between interest rates and exchange rates has been a debatable issue in economics literature. Dash (2004) found that call money rate has negatively and significantly influenced the exchange rate in India. In other words, declines in the value of the exchange rate have prompted monetary authorities to raise domestic interest rates. Another study by Wilson & Sheefeni (2014) found that for Namibia, there is no relationship between interest rates and exchange rates. Kisaka (2014) found that exists a long-run relationship between the foreign exchange rates and interest rates and there is unidirectional causality running from interest rates to foreign exchange rates in Kenya. Since the causation runs from interest rates to foreign exchange rates then authorities in the Kenyan financial markets use interest rates to stabilize the foreign exchange rates in Kenya. Tafa (2015) found that in the case of Albania, an increase in interest rates of deposits in ALL, caused the exchange rate of ALL/USD to increase, with USD becoming more expensive. While in the case of EUR/ALL exchange rate, it was found that when interest rate in ALL deposits increase, ALL was appreciating against Euro. Therefore, Lek (currecy of Albania) was becoming more expensive. Kayhan (2013) interest rate affects exchange rate in only China and this effect exist only in the long run. On the other hand, exchange rate shocks induce changes in interest rate in the shorter period. In Sri Lanka, although the causal relationship between inflation and exchange rate for instance, Perera (1997) found that even though Exchange Rate effect on Consumer price index, does not effect on wholesale price index in Sri Lanka. And also a dynamic relationship between activities of share market and short run interest rates has been attracted by previous researchers, there is lack of studies about the relationship between interest rate and exchange rates in Sri Lanka. On the other hand, previous researchers used only one interest rate for their research even though there are various different interest rates pertaining to diverse financial assets which are expected to have different relation with exchange rates. This study attempts to fill this void by examining the causal relationship between different interest rates and exchange rate in Sri Lanka.en-USInterest RateExchange RateCausalityCointegrationArticle