The Sri Lanka central bank reserves surge in August 2025 marks a notable shift in the country’s monetary landscape. Official data shows net foreign assets climbing as inflationary swaps unwind, offering temporary relief to reserve pressures.
Sri Lanka central bank reserves rise as inflationary swaps ease, signaling a key monetary policy shift.
Sri Lanka’s central bank has recorded a significant increase in net foreign assets, rising to the equivalent of 1,710 million US dollars in August 2025 from 1,468 million dollars a month earlier. This upward movement comes after months of modest gains and signals an important moment in the nation’s monetary policy strategy.
According to official data, the rise in Sri Lanka central bank reserves follows a reduction in inflationary swaps, which had previously been injecting liquidity into the financial system and constraining the bank’s ability to build reserves. The unwinding of these swaps effectively withdraws excess liquidity from money markets and reduces the capacity to issue fresh domestic credit, stabilizing reserve levels in the process.
For much of 2025, Sri Lanka’s central bank struggled to accumulate reserves under the current International Monetary Fund (IMF) program after a key requirement to sell down domestic assets was removed. Inflationary swaps with domestic banks fell to 3,680 million US dollars in August, down from 3,845 million in July. While this decline may appear modest, analysts say it represents a turning point that could ease pressure on the reserve position.
Monetary analysts have long warned that inflationary swaps and open market operations can make reserve accumulation challenging and may eventually trigger foreign exchange shortages, increasing the risk of another default. The recent developments suggest that policymakers may be taking steps to ease these pressures, though long-term stability will require sustained discipline.
Critics of the current IMF framework argue that the absence of a declining ceiling on domestic assets undermines the effectiveness of deflationary policy needed for sustained reserve growth. This structural gap, they say, echoes historical mistakes that contributed to severe economic crises in the past, including the Great Depression of the 1920s.
Economic historian Bellwether notes that similar policies — rooted in inflationary monetary frameworks designed by New York Fed chief Norman Strong and Bank of England Governor Montagu Norman — led to asset bubbles, price inflation, and eventual political instability. “These strategies have historically resulted in monetary instability, social unrest, and even defaults,” Bellwether explains, adding that political leaders often face blame for consequences rooted in technical monetary policies they do not fully control.
The reduction in inflationary swaps this time is not fully explained, but analysts point to local banks channeling funds toward foreign governments and regional borrowers, responding to higher global interest rates. This shift in financial flows could also be contributing to easing domestic liquidity conditions, creating room for the central bank to rebuild reserves.
Meanwhile, the Sri Lankan rupee has continued to depreciate steadily in 2025, despite record current account surpluses. Inflationist narratives from central bankers and the IMF traditionally argue that currency depreciation stems from current account deficits. However, this year’s data suggests the depreciation is linked more closely to monetary operations than to trade imbalances.
The current reserve buildup, while encouraging, remains fragile. Without consistent deflationary policies and better coordination with fiscal frameworks, gains can easily be reversed. Analysts caution that Sri Lanka’s central bank must balance liquidity management with longer-term structural reforms to maintain a sustainable external position.
The broader lesson, experts argue, is that central bank operational frameworks need to be better understood and carefully managed to avoid repeating cycles of inflation, depreciation, and default. While the August increase in reserves is a positive development, the underlying vulnerabilities in the monetary system have not disappeared.