"To prevent the depreciation of the Rupee, the Sri Lankan Central Bank intervened in the foreign exchange market by selling its US Dollars to purchase the Rupees, resulting in a decline in foreign exchange reserves."

Under a 'hard' or 'credible' peg a monetary authority would allow the status quo to remain and the exchange rate would hold, thought the money supply would shrink and interest rates would rise.

Such regimes are found in both Singapore and Honk Kong and are known as non-sterilized intervention.

But under a 'soft-peg' the central bank would simultaneously intervene in the domestic money market, printing new money to 'sterilize' the intervention and increase the supply of local rupees to resist a contraction in the domestic monetary base or a rise in domestic interest rates.

The simultaneous targeting of both the exchange rate and interest rates results in a spiraling loss of reserves or 'currency crisis'. A 'float' or rapid depreciation is needed to arrest the self-feeding cycle of peg-defence and liquidity injections (money printing).

Countries that get into such crises usually end up with the International Monetary Fund, which was created especially to help countries that operated 'soft-pegs' or 'managed floats' under the post World War II Bretton Woods agreement.

Sri Lanka is now negotiating an IMF bailout with foreign reserves halved from September to December when active peg defence began.

The ADB document said Sri Lankan apparel exporters were having a tougher time than those in India or Bangladesh.

"The risk of textile exporters’ orders being cut is more probable for Sri Lanka than India and Bangladesh because the Sri Lankan garment exports industry faces increased challenges," the study said.

"There is a serious shortage of skilled labour which is driving labour costs up. Labour costs of unskilled labour are also becoming impractically high for exporters operating in a highly competitive market.

"Higher labour costs have already forced some garment factories in the country to shut down or downscale."

Sri Lanka has had high inflation since 2004, when monetary and fiscal policy loosened simultaneously but the rupee was propped up with the help of periodic doses of foreign borrowings.

But now foreign markets were increasingly difficult to access.

In 2008 inflation hit 28.2 percent in April but has since fallen sharply. Inflation has since fallen to single digits. High domestic inflation drives up labour costs in particular, which causes a currency to be 'overvalued'.

The study said the currency should be depreciated only where "exchange rates are clearly misaligned".

Only a depreciation or a rapid moving up the value chain can allow exporters to survive and prevent an economic contraction or job losses.

The ADB study said aggressive monetary easing could be sustained where policy had been tight earlier and fiscal easing could also be considered.

"However, caution should be exercised: where fiscal deficits are already high and the public sector debt to GDP (gross domestic product) ratio is high," the study said.

"In such cases, expansionary fiscal policy could provoke concerns in financial markets which then negate the stimulus effect."