Sri Lanka’s net foreign reserves moved into positive territory in October 2024, with reserves exceeding reserve-related liabilities by approximately 63 million US dollars, according to official data. This shift follows two years of deflationary policies supported by elevated interest rates.
The country’s central bank had seen its reserves turn negative by 4.6 billion US dollars during previous years, attributed to policy missteps such as inflationary direct and open market operations following premature rate cuts.
To address the reserve shortfall, the central bank engaged in reserve borrowing via swaps and utilized a special drawing rights (SDR) allocation from the International Monetary Fund (IMF). However, mismanagement of rates through flawed policy measures ultimately resulted in a sovereign default.
The central bank’s policies led to a transmission mechanism, which propagated misaligned rates along the yield curve, further exacerbating economic challenges. During the last currency crisis, Sri Lanka already had outstanding IMF loans tied to prior currency crises, which were triggered by similar rate-cut policies.
When the currency collapsed due to inflationary open market operations, the interventions sterilized with swap proceeds culminated in massive central bank losses, highlighting the ongoing risks of misaligned monetary policies.
Sri Lanka’s return to positive reserves is a notable milestone, but the country continues to grapple with the repercussions of past policy missteps and seeks sustainable recovery paths for economic stability.