Sri Lanka central bank reserves declined in November 2025 as net foreign exchange holdings fell ahead of Cyclone Ditwah, while reliance on foreign exchange swaps increased despite ongoing engagement with the International Monetary Fund, according to official data.
Sri Lanka central bank reserves weaken as swap exposure grows before cyclone
Sri Lanka central bank reserves showed a notable deterioration in the months preceding Cyclone Ditwah, with official figures indicating a sharp fall in net foreign exchange reserves alongside a rise in foreign exchange swaps. Data released by the monetary authority reveal that reserves net of swaps declined to 2.298 billion US dollars in November 2025, down from 2.533 billion dollars in October.
The decline occurred before the country received a fresh emergency loan from the International Monetary Fund following the cyclone. In contrast, reserves net of swaps had stood at approximately 2.482 billion dollars in January 2025, highlighting a gradual erosion over the course of the year. Gross official reserves, however, remained largely unchanged during this period.
At the same time, the central bank’s exposure through buy-sell foreign exchange swaps increased. In January 2025, total swap obligations, including arrangements with the People’s Bank of China, amounted to 3.548 billion dollars. By November, buy-sell swaps alone had climbed to 3.794 billion dollars, underscoring a growing reliance on derivative-based liquidity management.
Sri Lanka central bank reserves metrics are closely watched by analysts because buy-sell swaps are considered inflationary in nature. These operations effectively monetize foreign currency holdings of commercial banks by providing newly created local currency, which can then expand credit and stimulate imports. The foreign exchange risk associated with such transactions ultimately rests with the central bank, rather than the private sector.
Although the IMF-supported program has imposed limits on sovereign guarantees for government borrowing, critics note that there are no explicit restrictions on the extent of foreign exchange risk the central bank can accumulate. This gap has drawn scrutiny from oversight bodies, particularly given historical losses linked to swap operations.
During the previous balance of payments crisis, a surrender rule triggered a collapse in the currency and resulted in an estimated loss of around 700 billion rupees on swap positions held by the central bank. The Committee on Public Finance of Sri Lanka’s parliament has since questioned the continued use of complex derivatives, warning that such practices can amplify systemic risk.
Sri Lanka central bank reserves are also under pressure due to outstanding obligations to regional lenders, including India. A portion of these liabilities is linked to funds borrowed to suppress interest rates during the last economic crisis, partly through swap arrangements. Analysts argue that rebuilding reserves on a lasting basis requires a deflationary policy stance, meaning that rupees generated through foreign exchange purchases must be fully extinguished.
In practice, deflationary measures in 2025 were limited largely to interest payments on the central bank’s restructured domestic bond holdings. This constrained approach reduced the effectiveness of reserve accumulation and left the monetary framework vulnerable to renewed currency pressure.
In December, following the impact of Cyclone Ditwah, the IMF disbursed 206 million dollars through an emergency facility. This marked the country’s 18th IMF loan, coming after delays to the main program caused by additional budgetary spending. While the funds provided short-term relief, analysts cautioned that underlying reserve dynamics remained fragile.
Throughout 2025, several analysts warned that reserve projections under the IMF program were weakened by flaws in quantitative targets that did not require the central bank to reduce its bond holdings. Since money creation occurs when dollars are purchased by the central bank, excess liquidity eventually feeds back into the foreign exchange market through imports and credit expansion.
If these dollars are not recycled through offsetting measures, downward pressure on the currency intensifies. During 2025, the rupee depreciated from around 290 to approximately 310 against the US dollar. Unsterilized liquidity from swap operations could exert similar pressure unless neutralized through offsetting foreign exchange sales.
Some stabilization was achieved when dollars were sold to the government through unsterilized transactions, preventing a sharper currency decline. Nevertheless, economists argue that exchange rates are not purely market outcomes but reflect the underlying operating framework of monetary authorities. In floating or flexible regimes, currency outcomes are ultimately shaped by monetary policy consistency.
Critics maintain that Sri Lanka’s inflation-prone operating framework has contributed to repeated currency crises since the end of the civil conflict, culminating in sovereign default and policy reversals. Without stronger institutional constraints and accountability, they warn that reserve volatility is likely to persist.