diff --git a/bundled/tool/lsp_server.py b/bundled/tool/lsp_server.py
index d3c630a..1af2a06 100644
--- a/bundled/tool/lsp_server.py
+++ b/bundled/tool/lsp_server.py
@@ -368,6 +368,19 @@ def _get_settings_by_document(document: workspace.Document | None):
 # *****************************************************
 # Internal execution APIs.
 # *****************************************************
+def get_cwd(settings: Dict[str, Any], document: Optional[workspace.Document]) -> str:
+    """Returns cwd for the given settings and document."""
+    if settings["cwd"] == "${workspaceFolder}":
+        return settings["workspaceFS"]
+
+    if settings["cwd"] == "${fileDirname}":
+        if document is not None:
+            return os.fspath(pathlib.Path(document.path).parent)
+        return settings["workspaceFS"]
+
+    return settings["cwd"]
+
+
 # pylint: disable=too-many-branches
 def _run_tool_on_document(
     document: workspace.Document,
@@ -393,7 +406,7 @@ def _run_tool_on_document(
     settings = copy.deepcopy(_get_settings_by_document(document))
 
     code_workspace = settings["workspaceFS"]
-    cwd = settings["cwd"]
+    cwd = get_cwd(settings, document)
 
     use_path = False
     use_rpc = False
@@ -476,7 +489,7 @@ def _run_tool_on_document(
 def _run_tool(extra_args: Sequence[str], settings: Dict[str, Any]) -> utils.RunResult:
     """Runs tool."""
     code_workspace = settings["workspaceFS"]
-    cwd = settings["cwd"]
+    cwd = get_cwd(settings, None)
 
     use_path = False
     use_rpc = False
diff --git a/src/common/server.ts b/src/common/server.ts
index affb971..0204b1e 100644
--- a/src/common/server.ts
+++ b/src/common/server.ts
@@ -2,7 +2,7 @@
 // Licensed under the MIT License.
 
 import * as fsapi from 'fs-extra';
-import { Disposable, env, l10n, LanguageStatusSeverity, LogOutputChannel, WorkspaceFolder } from 'vscode';
+import { Disposable, env, l10n, LanguageStatusSeverity, LogOutputChannel, Uri, WorkspaceFolder } from 'vscode';
 import { State } from 'vscode-languageclient';
 import {
     LanguageClient,
@@ -28,7 +28,7 @@ async function createServer(
     initializationOptions: IInitOptions,
 ): Promise<LanguageClient> {
     const command = settings.interpreter[0];
-    const cwd = settings.cwd;
+    const cwd = settings.cwd === '${fileDirname}' ? Uri.parse(settings.workspace).fsPath : settings.cwd;
 
     // Set debugger path needed for debugging python code.
     const newEnv = { ...process.env };