By: Staff Writer
August 10, Colombo (LNW): Sri Lanka’s gross official foreign reserves rose by 64 million US dollars in July 2025 to 6.14 billion dollars, Central Bank data show, marking a modest gain after months of stagnation.
However, concerns are mounting that recent interest rate cuts could undermine reserve accumulation and debt repayment capacity.
The latest figure remains below the 6.47 billion dollars recorded in October 2025. For the past nine months, the Central Bank has struggled to expand reserves, hampered by policy decisions and debt servicing obligations.
In late 2024, the bank’s strategy of injecting liquidity to maintain a single policy rate disrupted the interbank money market and contributed to foreign currency shortages.
At current interest rate levels, the Central Bank has been able to collect some dollars from the banking system, helped by halting inflationary open market operations. Still, a significant share of inflows is committed to external obligations.
The bank must supply foreign currency to the Finance Ministry for sovereign debt and interest payments, while also servicing its own liabilities—around 75 million dollars monthly to India—and repaying IMF loans from past crises.
Analysts warn these commitments leave little room for an independent monetary policy. Cutting rates to target inflation without considering reserve sustainability could edge the country closer to another sovereign default, they caution.
Reserve stability in recent months has partly relied on buy-sell swap arrangements, which provide short-term support but carry foreign exchange risk.
The Central Bank maintains that the rupee operates under a flexible exchange rate, yet depreciation pressures from rate cuts and liquidity injections could magnify losses.
Market swaps allow banks to issue loans without boosting rupee deposits, keeping deposit rates artificially low. According to economic analyst Bellwether, this could weaken the financial system’s ability to sustainably fund lending or government security purchases.
While gross reserves may appear steady under these swaps, net foreign reserves could decline—a reversal of the steady improvement seen even after October 2025, when rate cuts and open market operations slowed reserve growth.
In July, for instance, the Central Bank purchased 81 million dollars from the market under the current policy framework. However, nearly the entire amount—75 million dollars—was allocated to repay India before any funds could be directed to government debt servicing.
Economists have criticised the continued reliance on “flexible inflation targeting” and the belief that rates can be cut solely on the basis of past inflation trends.
They argue that such policies, coupled with currency depreciation and excess liquidity, contradict classical economic principles and risk long-term stability.
Sri Lanka’s exchange controls further complicate monetary management, creating “anchor conflicts” that intensify as economic growth and private credit rebound.
Analysts say the country’s high private savings rate could make exchange rate stability, reserve accumulation, and debt repayment far easier—if Parliament imposes tighter constitutional and operational constraints on discretionary monetary policy.
For now, the July reserve uptick offers limited comfort, with underlying vulnerabilities suggesting that without structural reforms, the improvement may prove short-lived.
