A Measurement for Financial Liberalization: An Application to Sri Lanka

Financial liberalization is a process of liberalizing the financial system of an economy by reducing controls in interest rates, financial intermediaries, and markets. Since the mid 1980s the World Bank and International Monetary Fund (IMF) started financial liberalization as a basic frame work for developing member countries to accelerate economic growth.Sri Lanka has been involved this process since 1977.This study attempts to establish an index for evaluation the complex process of financial liberalization in Sri Lanka by focusing on important changes in the financial sector. The study has used ten major policy components of financial liberalization to construct financial liberalization index at a particular time. In order to derive the index, arbitrary value is assigned to each of the policy variables. Each policy variable can take a value between 0 and1.The value is depending on the implementation phases of the policy. Time series annual data from1977 to 2011 are used to construct the index. The principle Component Method is used as an analysis method. This index is helpful to evaluate the impact of financial liberalization policies on various aspect of the economy. The constructed index shows that financial liberalization has gradually increased from 1997to 2011, though the policies are implemented since 1977 in Sri Lanka. Keywords: Financial Liberalization, Liberalization Index, Principle Component Method