ECONOMYNEXT – Sri Lanka’s external financial account was in deficit by 610 million US dollars, central bank data showed, as the country repaid debt and built net reserves by squeezing the current account.
In Mercantilist terms and in the popular press financial outflows are sometimes called ‘capital flight’.
In order for a country to be able to repay debt, savings have to be appropriated either by taxation or borrowings, reducing domestic credit and consumption, by the people who repay or build reserves at market interest rates.
Sri Lanka’s financial account has been in deficit since the last quarter of 2022, amid unusual debt repayments, when the central bank established monetary stability.
Sri Lanka has to make debt repayments on a net basis and also build reserves (which is the same as debt repayments), with most capital inflows drying up.
If domestic interest rates are not manipulated down by macro-economists, it is easy to repay debt or build reserves, or make private outward investments.
If no money is printed to push down rates, the balance of payments remains in balance.
In the fourth quarter of 2024, Sri Lanka’s current account turned into a deficit as large volumes of money were printed to target a mid-corridor (or single policy rate) and debt repayments were met with the help of budget support loans.
Analysts have warned that if rates are cut, claiming that inflation was low and that there was ‘space’ to do so based on a historical inflation index, the country will end up running down reserves as in 2012, 2015, 2018 and 2020 and the country will default again.
Countries get into trouble due to a belief (initially fostered in particular by John Maynard Keynes) that somehow a current account surplus was necessary to make large outward payments, when Germany found it difficult to make repayments.
Classical economists (including Stockholm economist Bertil Ohlin and French central banker Jacques Rueff) pointed out at the time that it was money printing by the Reichsbank that created external payments difficulties and massive imports and trade deficits.
The trade deficit was also driven by foreign borrowings by Germany after the war, they pointed out. Because Keynes failed to understand the problem, generations of Cambridge economists were created who had no idea how the balance of payments worked and how banks of issue (and impacted the balance of payments.
The current Trump tariffs are also triggered by the failure to understand how financial inflows trigger trade deficits with wildcat tariff being devised under the leadership Harvard graduate Peter Navarro.
Western central banks started to have severe monetary troubles without war in the 1930s, after open market operations were used to to centrally plan interest rates, triggering widespread peacetime currency collapses and protectionism.
Classical economist Friedrich Hayek, commented in a later interview that Keynes appeared to have no knowledge of the 19th century monetary debates of his own country but only and only Marshallian economics.
The 19 century monetary debates, which were in-depth inquiries into operating frameworks, led to the parliament imposing strict controls on the Bank of England, making the Sterling the pre-eminent global currency since the Roman Solidus and Britain a massive industrial and naval power.
Hayek later helped restore the Sterling and end exchange controls interacting with Prime Minister Margaret Thatcher and Keith Joseph in particular ending four decades of exchange controls that started shortly after the nationalization of Bank of England. (Colombo/July19/2025)
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