ECONOMYNEXT – Sri Lanka’s central bank has bought 177.3 US dollars from commercial banks in September 2025, up from 142.5 million US dollars in August, taking the total so far in 2025 to 1,415.9 million US dollars, official data show.
In late 2024, the central bank lost the ability to buy dollars as it printed almost 100 billion rupees through inflationary open market operations to mis-target call money rates ending a scarce reserve regime for the ‘single’ policy rate, triggering a public outcry.
However, purchasing dollars and keeping excess liquidity high, including through dollar-rupee buy-sell swaps, downward pressure can be maintained on the rupee.
Ironically, the depreciation came amid a two billion US dollar current account surplus.
For decades (especially since aggressive ‘monetary policy’ was operated in the US for full employment policies since the 1960s leading to the collapse of the Bretton Woods) Mercantilists in Sri Lanka and elsewhere who had rejected classical economics had claimed that current account deficits where the cause of external trouble and not their flawed operating frameworks.
So far this year, the central bank had bought 1,416.5 million US dollars to build up liquidity through unsterilized purchases and put downward pressure on the rupee.
If liquidity is built up and they are not redeemed through dollar sales when bank credit turns the rupees into imports, the currency will depreciate.
Unexpectedly, relief had come to the general public through unsterilized sales of dollars to the Treasury, which reduces excess liquidity, keeps interest rates in balance and reduces potential downward pressure, which are not disclosed to the public.
Up to June the central bank had sold over 700 million dollars of purchased dollars to the Treasury, data calculated backward from a domestic operations report shows.
If a central bank does not operate a political policy rate (i.e ‘monetary policy’) and engages only in unsterilized sales and purchase of foreign exchange, a fixed exchange rate can be operated indefinitely as happens in the GCC and some East Asian export countries and now also in Cambodia.
However, the monetary authority cannot build significant new forex reserves without deflationary policy (mopping up or contractionary sterilizing operations) as the dollars would be demanded by the Treasury or any other private agent that gets access to the new excess liquidity.
In the current IMF program which is to be re-negotiated there is no restraint on inflationism, through a requirement to sell down the central bank’s domestic asset stock.
At the moment the only deflationary operations are the coupon payments into the central bank by the Treasury for its long-term bond portfolio.
Critics had pointed out that Sri Lanka’s central bank is only answerable to the IMF and the parliament has no real control over the agency, as democracies did before depreciation and the age-of-inflation.
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It is not clear why macro-economists are depreciating the rupee in 2025, but it may be to push up the cost of living to meet a self-imposed high inflation target.
There is growing pressure to reduce the inflation target, which is now higher than savings deposit rates, and also make it a ceiling which will give the parliament more control to counter inflationism from ‘macroeconomic’ policy which led to the first default.
Macro-economists had turned an inflation target into a floor, a development which analysts say also took place in Europe insidiously since the firing and collapse of the housing bubble from Fed ‘reflation’.
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At the moment inflationary open market operations are also in abeyance, though a ‘single policy rate’ has been legalized through subsidiary legislation allowing macroeconomists to scrap a scarce reserve regime critics had pointed out.
On October 02 banks borrowed 21 billion rupees overnight at the ceiling (so-called Lombard) rate of 8.25 percent and 6.17 billion rupees on October 03, above the single policy rate of 7.75 percent, keeping a scarce reserve regime in operation.
If money is printed to obstinately target a single policy rate as advocated by IMF technical assistance, using liquidity forecasts to undermine the workings of the interbank money market, the central bank will lose the ability to collect dollars to either build reserves or to give to the Treasury to repay debt and a second default is inevitable, analysts have warned.
Though there are no inflationary open market operations, and banks have to raise deposits to make loans, concerns have been raised that inflationary swaps will contribute to depreciation and net reserve losses.
It is not clear when inflationary open market operations would resume. Sri Lanka has exchange controls indicating that the central bank’s operating framework is deeply flawed and has been so for many years.
The Treasury also quickly loses control over primary expenditure when there is inflation and depreciation (a problem that started in 1980s after the IMF’s Second Amendment) and eventually nominal interest rates have to be jacked up steeply to stop the ensuing currency crisis.
Until Sri Lanka gets market access around 2028, the country has to repay amortizing debt absolutely and the ability to repay debt (which triggers a current account surplus) has to be ensured, for which suitable interest rates, analysts say. (Colombo/Oct07/2025)
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