Sri Lanka private credit growth slowed sharply in December 2025 as government borrowing accelerated and Treasury bill yields climbed. Official data shows a clear shift in banking sector lending patterns during a month marked by Ditwah relief payments and tightening liquidity conditions.
Sri Lanka private credit cools amid Ditwah relief and rising Treasury yields
Sri Lanka private credit recorded a notable slowdown in December 2025, reflecting a decisive shift in domestic liquidity toward government financing as Treasury bill yields rose and state borrowing expanded. Central bank data shows lending to private borrowers from commercial banks fell to 182.8 billion rupees in December, down from a peak of 262 billion rupees in November.
Despite the December moderation, banks extended a cumulative 2,056 billion rupees in loans to private borrowers during 2025, indicating that the broader credit cycle remained supportive of non-government economic activity. This included lending linked to vehicle purchases, a segment that indirectly supports fiscal revenue through import taxes and duties, easing pressure on the budget deficit.
The December reversal coincided with a sharp rise in net credit to government, which increased by 194.7 billion rupees during the month, reversing a contraction of 103.5 billion rupees recorded in November. The expansion reflected elevated financing needs as the government made Ditwah relief payments while allowing short-term interest rates to adjust upward.
Treasury bill yields spiked in December, a move analysts say played a critical role in stabilising the broader macroeconomic framework. By permitting market rates to rise, the Public Debt Management Office reduced excess liquidity pressures that could otherwise have spilled into the foreign exchange market. Observers argue this decision helped avert the early stages of a renewed balance-of-payments crisis.
Sri Lanka’s monetary framework has long relied on a so-called domestic liquidity buffer, built when public debt was held under the central bank. The intention was to influence interest rates through deposit placements in state-owned banks. However, analysts have repeatedly pointed out that such buffers offer limited control over rates, as deposits are recycled into interbank lending or Treasury securities rather than remaining idle.
When government deposits are withdrawn to meet spending obligations, affected banks are forced to adjust rapidly. This can include cutting interbank credit lines, slowing new private lending, or reducing participation in Treasury auctions. In such conditions, attempts by the central bank to offset the tightening through open market injections risk expanding the monetary base, potentially placing renewed pressure on the currency.
In December, the authorities refrained from inflationary open market operations and allowed interbank rates to rise, a stance that prevented crowding out of private sector credit through artificial liquidity support. Higher bill rates helped absorb the credit shock internally, limiting the risk of external imbalances forming.
Natural disasters have historically influenced credit trends in Sri Lanka, often dampening private borrowing while generating capital inflows that place appreciation pressure on the rupee. December 2025 followed a similar pattern due to Ditwah-related disruptions, although policy responses differed from past episodes.
Unlike during the post-tsunami period, the central bank continued purchasing foreign exchange beyond its deflationary stance, effectively preventing rupee appreciation. This occurred despite a public call in November by President Anura Dissanayake to halt monetary depreciation, echoing earlier reformist arguments made during previous policy debates.
In 2018, economist and former bank treasurer Harsha de Silva had outlined a framework for strengthening the currency by allowing overnight interbank rates to move toward the upper bound of the policy corridor. He argued that tolerating tighter short-term rates, even at the cost of slower growth, was necessary to restore exchange-rate stability and credibility.
That earlier period was marked by sterilised interventions, where liquidity was injected to offset reserve sales, creating a cycle of repeated market distortion. In contrast, during 2025 the central bank sold foreign reserves to the government and private sector without sterilisation, amounting to roughly 117 million dollars. This reduced excess liquidity and pushed interbank rates higher, limiting depreciation risks.
By December, interbank rates rose to around 8.10 percent, approximately 35 basis points above the single policy rate. This allowed banks to attract deposits more aggressively, helping the system absorb fiscal-driven liquidity shocks without triggering currency stress.
As 2026 began, interest rates showed early signs of easing. However, analysts caution that renewed efforts to suppress short-term rate volatility through expansionary operations could undermine recent stability gains. Abandoning a scarce-reserve framework in favour of rigid rate targeting has historically preceded currency weakness and sovereign stress.
Sri Lanka’s long experience with monetary depreciation underscores the importance of consistent operating rules. Economists argue that exchange-rate instability remains a visible indicator of structural weaknesses in monetary governance, particularly when compared with systems that prioritise disciplined liquidity management and market-driven interest rates.