Sri Lanka cash buffer costs have come under scrutiny after officials revealed that maintaining excess domestic borrowings is adding an estimated two percent interest burden, prompting plans to scale back the practice amid tightening fiscal and monetary conditions.
Sri Lanka cash buffer strategy adds costs as Treasury trims excess borrowings
Sri Lanka’s approach to maintaining a domestic cash buffer through overborrowing has drawn renewed attention after officials told Parliament that the strategy is imposing a measurable financial cost on the Treasury. Evidence presented to the Committee on Public Finance (COPF) indicates that excess borrowing, estimated at around 1.2 trillion rupees by late November, carries an additional interest cost of roughly two percent.
Additional Director General of Treasury Operations Damitha Rathnayake told the committee that the gap between the cost of borrowing and the returns generated from holding the funds had become increasingly difficult to justify. “There is a margin of about two percent between the borrowing and the return we get,” she said, adding that the Treasury has already begun reducing the size of the buffer.
While the precise nature of the two percent cost was not fully clarified, analysts said it may reflect either an average cost across instruments or the marginal cost of issuing longer-term government bonds while relying less on cheaper short-term Treasury bills. In Sri Lanka’s current financial environment, short-term liquidity remains abundant, largely because volatility driven by repeated currency crises has discouraged investors from holding longer-dated government securities.
Officials indicated that by the end of the year, excess borrowings would likely be reduced to around one trillion rupees. President Anura Kumara Dissanayake had earlier told Parliament that surplus borrowings stood at approximately 1.2 trillion rupees by the end of November. Of this amount, around 500 billion rupees is expected to be utilised for hurricane relief and recovery-related expenditure, reducing the overall buffer.
Authorities have also outlined plans to maintain a more modest reserve equivalent to around three months of debt servicing requirements, estimated at between 500 and 600 billion rupees. These funds are currently deposited in state-owned commercial banks, forming what officials describe as a precautionary liquidity cushion.
Rathnayake told the COPF that the Sri Lanka cash buffer was initially built up as a substitute for money printing, with the intention of meeting short-term fiscal needs without resorting to inflationary financing. However, market analysts have long cautioned that domestic “reserves” held within the local banking system do not function like true rainy-day funds.
According to analysts, cash deposited in commercial banks does not remain idle. Banks typically recycle excess liquidity through interbank lending, credit expansion, or the purchase of short-term government securities. This creates a circular flow that limits the buffer’s effectiveness as a shock absorber during periods of stress.
Analysts warned that any sudden withdrawal of large state deposits from banks could disrupt interbank markets, constrain credit availability, or temporarily weaken demand at Treasury bill auctions. Such dislocations could complicate liquidity management at a time when stability is critical.
For this reason, economists argue that genuine contingency reserves must be held externally, which is why many countries establish sovereign wealth funds or maintain foreign assets outside their domestic banking systems. Funds held abroad can be drawn down without destabilising local liquidity or credit markets.
Depositing excess cash at the central bank over extended periods could have a different effect. Analysts note that sustained deposits at the central bank’s deposit window would be deflationary, potentially increasing monetary foreign exchange reserves. These reserves could then be drawn down when liquidity is later withdrawn under a fixed exchange rate regime, offering a more orthodox buffer mechanism.
Historically, Treasury bills were designed precisely to address short-term government cash needs. Known as Exchequer Bills in classical Britain, these instruments transmit the government’s financing requirements to the market by influencing short-term interest rates. By doing so, they crowd out private credit when necessary, helping to prevent external imbalances or currency depreciation.
Government cash requirements can spike during extraordinary circumstances such as wars, natural disasters, or economic crises, when households and businesses are already under strain. In such conditions, careful management of borrowing and liquidity becomes critical to avoid compounding economic hardship.
Analysts caution that attempts to manipulate interest rates through inflationary open market operations can have unintended consequences. Artificially lowering rates often leads to currency depreciation, which in turn drives up food and energy prices, pushing vulnerable segments of the population further into difficulty.
Historical data underscores this point. When Sri Lanka’s central bank first embarked on what are now described as rate cuts in the early 1950s, long-term government securities were yielding below three percent, reflecting a stable monetary environment. Similarly, before the US Federal Reserve adopted inflationary open market operations, 30-year Liberty Bonds issued during World War I carried yields of around 3.5 percent and were widely purchased by ordinary citizens.
Against this backdrop, policymakers now face the challenge of balancing fiscal prudence, liquidity management, and economic stability. Scaling back the Sri Lanka cash buffer may reduce unnecessary interest costs, but analysts stress that any transition must be carefully managed to avoid disrupting markets or undermining confidence.