Sri Lanka Treasury bill yields have edged higher after months of unusual compression across maturities, signaling a shift away from artificially flat interest rates that in the past preceded currency stress and foreign exchange shortages.
Sri Lanka Treasury bill yields break long-standing flat rate pattern
Sri Lanka Treasury bill yields have moved higher, ending a prolonged period of unusually flat and compressed rates across tenures, according to market data. Analysts say the change marks a notable shift in domestic money market conditions, particularly given that similar anomalies in the past preceded currency depreciation and balance of payments pressures.
Historically, when public debt was managed directly under the Central Bank of Sri Lanka, Treasury bill yields were suppressed following policy rate cuts. These low yields were often enforced through inflationary open market operations, which rapidly generated foreign exchange shortages and triggered sharp currency depreciation. Such conditions eroded the usefulness of Treasury bills as a benchmark for pricing risk across the broader financial system.
In 2025, authorities operated under a scarce reserve regime, with a stated effort to limit money creation through domestic market operations. While outright liquidity injections were reduced, analysts note that non-market interest rate influences were still present through policy signaling, contributing to distortions in the yield curve.
After the end of the civil war, Treasury bill yields were pushed so low through intervention that they became ineffective as a pricing reference for corporate borrowing. As a result, markets shifted toward alternative benchmarks such as average weighted deposit rates. This weakened the signaling role of government securities and blurred the transmission of fiscal and monetary conditions to private credit markets.
Sri Lanka Treasury bill yields typically rise quickly when fiscal pressures intensify, communicating government funding needs to the market. Such increases may be temporary or seasonal but can crowd out private sector borrowing if sustained. In contrast, prolonged suppression of yields often masks underlying imbalances rather than resolving them.
Despite reduced domestic money printing in 2025, the rupee depreciated as excess liquidity accumulated from foreign exchange purchases that exceeded the central bank’s deflationary policy stance. Analysts have described this as a monetization of balance of payments inflows, where newly created rupees eventually return to the foreign exchange market through imports and credit expansion.
Some commentators have characterized the process more harshly, arguing that selective limits on currency convertibility after absorbing private foreign exchange inflows effectively transferred risk to the public balance sheet. These debates have intensified amid concerns that accountability for exchange rate stability weakened after changes to the global monetary framework in earlier decades.
Before the 1980s, Sri Lanka’s inflation and interest rate levels broadly tracked those of developed economies. Since then, critics argue that deviations in monetary operations have contributed to repeated currency crises. Recent pressures have been reflected in other sectors, including utilities, where the Ceylon Electricity Board has sought tariff increases as the rupee weakened despite declining global fuel prices. Fuel prices were raised again in January.
Sri Lanka Treasury bill yields do not necessarily need to rise across longer maturities if the medium-term fiscal path is credible and the currency remains stable. Analysts note that capital destruction through depreciation, rather than interest costs alone, poses the greater risk to long-term investment.
Rate cuts in 2025 also coincided with strong private credit growth under a flexible inflation-targeting framework. Some economists have warned that heavy reliance on statistical models without sufficient grounding in classical monetary theory could expose the economy to renewed external stress, particularly when reserve accumulation is a stated policy objective.
Movements in government yields have also influenced bank interest rates. A rapid transmission of fiscal or credit pressures can push deposit rates higher, encouraging savings while restraining consumption. Since the controversial rate cut in May, deposit rates have gradually increased, prompting banks to intensify deposit mobilization efforts during the latter part of the year.
Finance sector officials noted that banks faced constraints from interest rate controls earlier in the year, forcing aggressive competition for deposits. More recently, advertising-driven demand has moderated. Finance companies, which struggled to attract deposits, relied more heavily on bank credit lines, though access tightened temporarily before easing again.
Some lenders reported a slowdown in vehicle financing demand after loan-to-value ratios were tightened, even before Cyclone Ditwah. Vehicle importers also reported weaker sales in December. Meanwhile, the prime lending rate declined to 8.98 percent in mid-January 2026, down from 9.19 percent the previous week.
Amid strong credit growth, analysts have warned that reserve accumulation could again fall short, echoing post-war patterns that led to heavy external borrowing and eventual default. They argue that the true buffer lies not in past reserve levels but in maintaining interest rates that restrain excessive imports and credit growth, allowing external obligations to be serviced sustainably.