Effect of Exchange Rate Volatility on Sri Lanka's Inbound Tourist Flow

Abstract

This paper investigates effects of exchange rate volatility on Sri Lanka's inbound tourism using monthly data on tourist arrivals, exchange rate and other related variables from 1990 to 2016. An Exponential Generalized Autoregressive Conditional Heteroscedasticity (EGARCH) model is used to generate a measure of exchange rate volatility. This is then incorporated in a tourism demand model to test its impact on tourist flows into the country. The empirical methodology depends on the theory of cointegration and error correction representation. The results reveal that there are significant negative short run and long run effects of exchange rate volatility on tourist flows to Sri Lanka. Further, it suggests that the Sri Lankan tourism product is a luxury good, having high income elasticity. In addition, tourism related inflation has a significant negative impact on the growth in tourist arrivals in the short run. However, in the long run, a reduction in price sensitivity is observed. Moreover, results highlight the significant positive impact of habit persistence or/and word of mouth recommendation in increasing tourist flows to Sri Lanka. It further reveals the importance of maintaining a conducive economic, political and social environment to increase the demand for Sri Lankan tourism.