DOMESTIC FINANCIAL MARKET AND THE TRADE LIBERALIZATION OUTCOME - EVIDENCE FROM SRI-LANKA

This paper develops a framework for analyzing the role of financial se ctor policies in determining the outcome of trade liberalization and a pplies it to Sri Lanka's experience during 1977-87. It is found that f inancial liberalization complements trade liberalization on both deman d and supply sides. On the demand side, interest rate deregulation aff ords opportunities for those earning increased income from a trade lib eralization to hold financial assets as alternatives to nontradables. This facilitates economic adjustment in the trade liberalization conte xt by preventing a premature appreciation of the exchange rate. On the supply side, financial reform augments loanable funds and facilitates their reallocation into private sector investment stimulated by trade liberalization.