The Sri Lanka central bank net reserves rose to USD 1.71 billion in August 2025, reflecting improved liquidity and the partial unwinding of inflationary swaps. Analysts note this signals both stability and ongoing challenges in reserve management.
Sri Lanka central bank net reserves climb as some inflationary swaps unwind
The Sri Lanka central bank net reserves increased to 1,710 million US dollars in August 2025, up from 1,468 million dollars in July, according to official data. This follows a marginal rise in the previous month and highlights the effects of unwinding inflationary swaps with domestic banks.
Analysts point out that Sri Lanka’s central bank has faced constraints in collecting reserves during the current portion of the International Monetary Fund (IMF) program. The requirement to sell down domestic assets was removed in 2025, limiting the central bank’s ability to accumulate foreign assets efficiently.
Inflationary swaps with local banks have further complicated reserve management. These swaps inject liquidity into the domestic financial system but reduce the central bank’s capacity to collect reserves. In August 2025, inflationary swaps fell to 3,680 million US dollars from 3,845 million in July. The unwinding of buy-sell swaps, where the central bank acts as the counterparty, withdraws excess liquidity from money markets and limits the ability to provide fresh domestic credit.
Financial experts have warned that inflationary swaps and open market operations designed to inject liquidity make it difficult to sustain reserve growth. These mechanisms can contribute to foreign exchange shortages and heighten the risk of a second sovereign default.
Some analysts critique the current IMF program, noting that it lacks a falling ceiling on domestic assets to enforce disciplined deflationary policy and sustained reserve accumulation. Historically, similar inflationary interventions have had destabilizing effects. Central bank policies under IMF technical assistance, which rely heavily on liquidity injections and swap operations, have occasionally trapped countries in cycles of program dependency and external defaults.
Historically, inflationary central banking strategies emerged in the 1920s and 1960s, triggering financial instability, asset price bubbles, and social unrest. EN economic columnist Bellwether explains that early architects of these policies, including New York Fed chief Norman Strong and Bank of England Governor Montagu Norman, often faced criticism from peers like Emile Moreau and Reichsbank chief Hjalmar Schacht for causing unintended economic consequences.
“These policies ultimately result in monetary instability, inflation, asset price bubbles, social unrest, and potential default,” Bellwether notes. “When the consequences emerge, politicians are blamed for not carrying out reforms, despite central bank frameworks being poorly understood by the public.”
The reason behind the reduction in inflationary swaps in August 2025 is unclear, but local banks have reportedly been financing foreign governments and regional borrowers, as global interest rates remain generally higher. Meanwhile, Sri Lanka’s rupee has steadily depreciated in 2025 amid record current account surpluses. IMF narratives and inflationist central bank arguments often attribute currency depreciation to current account deficits, though analysts argue this explanation overlooks the complex interplay of domestic monetary policies.
Overall, the rise in the Sri Lanka central bank net reserves provides a positive signal for short-term stability but also highlights structural challenges in managing liquidity, inflationary pressures, and foreign exchange. Policymakers and financial institutions must continue monitoring reserve flows carefully, balancing the need for domestic credit with the imperative to maintain foreign currency reserves.
The partial unwinding of inflationary swaps may offer some relief to the central bank’s balance sheet, yet analysts caution that further structural reforms and prudent policy adjustments are needed to ensure sustainable reserve accumulation and long-term financial stability.