Sri Lanka interbank rates ease as short-term money market indicators soften, signalling a slowdown in private credit growth while the central bank’s continued dollar purchases prevent the rupee from strengthening during the post-cyclone recovery.
Sri Lanka interbank rates ease as dollar purchases curb rupee gains
Sri Lanka’s money market conditions showed signs of easing over the past week, with key short-term interest rates declining in tandem, a development that typically reflects a moderation in private sector credit demand. Central bank data and market participants indicate that the easing occurred alongside significant foreign exchange purchases by monetary authorities, which limited appreciation pressure on the rupee following Cyclone Ditwah.
Weighted average call money rates, a key indicator of overnight liquidity conditions among banks, declined steadily in recent weeks. After averaging around 8.04 percent in December 2025, call money rates fell to approximately 7.79 percent by January 22, according to official figures. The movement suggests improved liquidity conditions in the interbank market, even as broader economic activity remains subdued.
Gilt-backed repurchase agreement rates followed a similar trajectory. Repo rates, which had risen to nearly 8.10 percent toward the end of December, eased to about 7.80 percent by January 22. These rates are closely monitored as they reflect the cost of secured short-term borrowing within the banking system. Their decline reinforces the view that credit expansion is slowing rather than accelerating.
While interbank rates softened, Treasury bill yields moved in the opposite direction in recent weeks. Market participants attribute this increase largely to government financing needs linked to cyclone relief payments. The resulting upward pressure on bill yields highlights the ongoing tension between fiscal requirements and monetary conditions, particularly in a post-disaster environment.
Historically, Sri Lanka has experienced a slowdown in credit growth following major natural disasters. Such slowdowns often reduce demand for foreign exchange, creating conditions that allow the domestic currency to strengthen if monetary authorities permit market forces to operate. A notable example occurred after the December 2004 tsunami, when reduced credit activity coincided with a sharp appreciation of the rupee after the central bank allowed it to adjust freely.
In the aftermath of Cyclone Ditwah, however, the exchange rate has not followed this historical pattern. Instead, the central bank has actively intervened in the foreign exchange market, purchasing more than 20 million US dollars from commercial banks, according to market participants. These transactions reportedly took place around 309.80 rupees to the dollar, effectively preventing the currency from appreciating despite easing domestic rates.
When the central bank purchases foreign currency in the domestic market, it injects new liquidity into the financial system. This process, often described as the monetisation of a balance of payments surplus, increases the money supply unless fully sterilised. The founding governor of Sri Lanka’s central bank previously cautioned that such practices can undermine monetary stability if not carefully managed.
A balance of payments surplus typically emerges when monetary policy maintains reserve discipline, limits excessive credit creation, and supports stable capital flows. Improvements in market operations and interest income from the central bank’s bond holdings have contributed to recent external stability. However, analysts argue that exchange rate management has diluted these gains by discouraging natural currency adjustment.
Concerns have been raised that continued intervention could undermine broader economic objectives, including efforts to reduce electricity tariffs and stabilise the cost of living. Sri Lanka’s recent history illustrates how currency weakness quickly feeds into higher energy and food prices, disproportionately affecting lower-income households. Analysts warn that renewed inflationary pressure could heighten social tensions in an already fragile recovery.
Since its establishment, Sri Lanka’s central bank has overseen a long-term depreciation of the rupee, from about 4.70 to the US dollar to levels exceeding 300 today. Much of this decline occurred after the 1980s, when monetary frameworks attempted to manage money supply growth without allowing a fully flexible exchange rate. These policy inconsistencies strained public finances and periodically triggered social unrest, eroding confidence in reform efforts.
Monetary instability intensified further after the end of the civil conflict, as accommodative policies aimed at boosting growth relied heavily on liquidity creation. Over time, this approach contributed to external imbalances and culminated in a sovereign default. Against this backdrop, the recent easing in interbank rates may reflect a necessary slowdown in credit, but sustained intervention in the currency market risks repeating earlier policy missteps.
As Sri Lanka interbank rates ease, the direction of exchange rate policy will remain critical in determining whether the economy consolidates its recovery or re-enters a cycle of instability driven by monetary and currency pressures.