Sri Lanka central bank forex sales exceeded 1.1 billion dollars in 2025 as authorities sold reserves to the government to repay debt. The transactions, carried out without sterilization, significantly influenced liquidity conditions, interest rates, and exchange rate dynamics.
Sri Lanka central bank forex sales reshape liquidity and debt repayment
Sri Lanka’s central bank undertook large-scale foreign exchange operations in 2025, selling more than 356 billion rupees worth of dollars—equivalent to over 1.1 billion US dollars—to the government to meet external debt repayments. Official data show that these transactions were unsterilized, meaning they directly affected domestic liquidity rather than being offset through open market operations.
At the same time, the central bank created substantial new money by purchasing foreign exchange on a net basis. Market operation data indicate that around 530 billion rupees were injected into the financial system through net dollar purchases, equivalent to roughly 1.7 billion US dollars at an average exchange rate of 301 rupees. This reflected the monetization of a balance of payments surplus, a process that typically increases liquidity and places downward pressure on overnight interest rates.
Unsterilized foreign exchange purchases tend to expand liquidity, encouraging credit growth and, eventually, higher imports through increased consumption and investment. In Sri Lanka’s case, analysts note that a relatively high private savings rate means consumption alone does not fully convert dollar inflows into imports. Credit expansion is required to transmit these flows into domestic demand, making liquidity management especially sensitive.
By contrast, unsterilized dollar sales—such as those used for debt repayment—have the opposite effect. They withdraw rupee liquidity from the system, pushing overnight rates upward and reversing the monetary impact of prior dollar purchases. This tightening effect can temporarily strengthen the currency, particularly when it coincides with broader deflationary measures.
During 2025, the central bank combined these reserve sales with other actions aimed at mopping up liquidity. It allowed around 6.7 billion rupees of Treasury bonds to mature, a move seen as a deviation from a long-standing “bills-only” approach during past crises. The intention was to influence longer-term interest rates while deliberately absorbing excess liquidity from the banking system.
Additional deflationary pressure came from coupon payments made by the Treasury to the central bank on its rupee-denominated bond holdings. These payments, amounting to nearly 190 billion rupees, further reduced liquidity. Such measures tend to constrain domestic investment credit and imports, often resulting in a balance of payments surplus as dollar outflows exceed inflows. That surplus can later be monetized through renewed foreign exchange purchases at a fixed exchange rate.
However, analysts caution that excessive dollar purchases can have destabilizing consequences. Over-monetization may lead to monetary depreciation, pushing up the domestic prices of imported and exportable goods. Rising prices for essentials such as food and energy can, in turn, trigger social and political pressures, especially in an economy still recovering from recent crises.
Despite falling global energy prices in 2025—partly due to tighter monetary conditions in advanced economies—Sri Lanka experienced fuel price increases following currency depreciation. This occurred even as coal prices declined, prompting renewed requests from the Ceylon Electricity Board for tariff increases. Such outcomes underscore the complex transmission from exchange rate movements to domestic prices.
Currency depreciation can also affect the public’s demand for base money. Net currency withdrawals during the year amounted to over 210 billion rupees, expanding notes in circulation. Classical economic observers have long noted that during periods of severe monetary depreciation or hyperinflation, shortages of physical currency can emerge as demand for cash rises sharply to meet higher nominal transaction values.
On the inflationary side, the central bank also expanded buy-sell swap operations in 2025. These swaps effectively monetized commercial bank dollar balances rather than current inflows or a balance of payments surplus, creating nearly 259 billion rupees in new money. When banks pass these rupees to customers through lending, or to the government via taxes and bond purchases, depreciation pressures can emerge if the central bank does not supply dollars back to the market at consistent rates.
Analysts argue that this mechanism contributed to the rapid weakening of the rupee during the year. The currency’s decline has been described as stemming from flaws in the operating framework, where dollars were purchased from the market but not returned to private importers at the same rate. This occurred despite an overall policy stance that was largely deflationary, apart from swap operations.
Historically, similar policy frameworks have been linked to broader episodes of monetary instability. Between the two World Wars, many countries experienced widespread currency depreciation following the adoption of aggressive open market operations and policy rate targeting. Those practices, later associated with Keynesian stimulus approaches, coincided with prolonged inflationary periods.
In Sri Lanka’s case, persistent monetary depreciation since the early 1980s has been linked by some economists to changes in international monetary arrangements and domestic policy choices. The resulting inflation has often exceeded that of advanced economies, contributing to social unrest and undermining confidence in economic reforms. Comparable dynamics have been observed in parts of Latin America and in heavily indebted economies that ultimately faced sovereign default.
Against this backdrop, the scale of Sri Lanka central bank forex sales in 2025 highlights the delicate balance policymakers face between debt repayment, liquidity management, and currency stability. The outcomes of these choices continue to shape inflation expectations, investor confidence, and the broader economic recovery.