By: Staff Writer
September 07, Colombo (LNW): Sri Lanka’s fragile foreign reserve recovery is under fresh pressure as private credit expansion accelerates, threatening the Central Bank’s ability to meet the USD 7 billion IMF year-end reserve target. Despite gross reserves edging up to USD 6.166 billion in August 2025, analysts warn that reserve collection could stall or even reverse unless deflationary monetary policy is re-applied to neutralize liquidity injections that accompany rising credit.
Reserves: Modest Gains, Lingering Vulnerabilities
Gross official reserves climbed USD 19 million in August, maintaining coverage above USD 6 billion.
However, this is still USD 306 million below October 2024 levels, when the Central Bank began operating an “abundant reserve regime” that injected liquidity to stabilize rates. Net reserves tell a more worrying story: in June 2025, they dropped from USD 1.541 billion to USD 1.414 billion, the sharpest fall since stabilization began in 2023. The decline coincided with faster private credit growth, raising concerns that reserve accumulation is being undermined by domestic lending booms.
Credit Expansion: Fuel for Growth, Risk for Stability
Private credit has expanded steadily in 2025 as interest rates were trimmed, giving businesses and households easier access to loans. While credit growth supports short-term economic activity, it injects liquidity into the banking system, weakening the Central Bank’s ability to purchase dollars and sterilize rupee flows. Without offsetting deflationary operations such as selling down government securities rising credit could push the exchange rate down and limit reserve build-up.
In the first half of 2025, the Central Bank also transferred USD 770 million to the government through unsterilized transactions. While necessary for fiscal financing, such outflows further constrained the space for genuine reserve accumulation.
IMF Target: A Narrow Window to Deliver
The IMF has set a USD 7.0 billion gross reserve target by December 2025, higher than the original USD 5.6 billion benchmark. With only USD 834 million still to accumulate, the target is technically achievable but only if credit expansion is restrained and fiscal authorities step in to purchase dollars directly. Treasury-led dollar buying, funded by market borrowings or tax revenues, would provide neutral reserve inflows without inflationary side-effects.
Tourism inflows (USD 401 million in January alone) and steady worker remittances continue to offer support, while IMF disbursements have provided a crucial cushion. Yet, analysts stress that these inflows are insufficient if domestic liquidity remains unchecked. Rate cuts, implemented through “signalling” rather than tight operations, risk undoing earlier stabilization gains.
Outlook: Tightrope between Growth and Reserve Security
Sri Lanka’s economy is forecast to grow 4.5% in 2025, with inflation stabilizing near 5% by mid-2026. Growth momentum has eased social tensions, but the danger lies in repeating past cycles: stimulating credit at the expense of external stability. Unless the Central Bank re-applies deflationary tools and coordinates closely with the Treasury on dollar purchases, the USD 7 billion reserve goal could slip beyond reach.
