ECONOMYEXT – Net foreign assets of Sri Lanka’s commercial banks rose to 1.74 billion US dollars in March 2025, up from 1.61 billion US dollars in February, official data showed as banks continued to build up overseas foreign currency positions.
Banks at the time borrowed abroad through credit lines and syndicated loans to give dollar loans to the government and buy Sri Lanka Development Banks over and above their foreign currency deposit balances.
Banks also bought sovereign bonds with the funds.
By 2021 bank net foreign assets were negative by around 4 billion US dollars.
Capital Flight
After the 2020 rate cuts triggered the biggest currency crisis in the central bank’s history, leading to credit downgrades, banks had to repay maturing foreign credit lines from new customer deposits as foreign creditors refused to roll-over lines.
Banks which were asked by the central bank to make provisions for Sri Lanka sovereign bonds also bought dollars in the domestic market and built up liquid forex balances.
After the rate cuts which triggered the crisis and default were reversed in April 2022, domestic credit slowed. Initially central bank’s reserves were pushed further into negative territory with the used of Indian credits.
The central bank started to collect reserves shortly after India stopped giving dollars to finance private imports, which requires liquidity injections and results in driving up the current account deficit.
Later banks were also repaid Sri Lanka Development Banks in local securities.
Banks then used rupee customer deposits and loan repayments to buy dollars, curtailing domestic credit and investments, which automatically generated the required dollars to purchase.
The overall balance of payment turned positive by September 2022 (which requires deflationary policy). The so-called overall balance is defined in relation to official assets.
Capital flight offset by credit contraction
Curtailing domestic credit allows foreign capital repayments to be made, leading to a narrowing of the external current account deficit or turning it into a surplus.
By March 2025 the net foreign assets of offshore banking units had climbed to 2.2 billion US dollars.
The net position of domestic banking units were still negative by 544 million US dollars by March. By April 2022 when the central bank hiked rates to end the crisis, DBU net position was negative by over 900 million US dollars.
The net position can improve due to new customer deposits, which are invested abroad, or local dollar loans being repaid.
The liquid dollar balances are now being invested in syndicate loans in India, among other investments.
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Commercial banks which collected dollars to cover for Sri Lanka Development Banks and ISB loss provisions placed their fund abroad short-term including at NOSTRO accounts, while some also bought securities like US Treasuries.
Sri Lanka has high savings rates and has absolutely no reason to have forex shortages or inability to repay debt, or even borrow heavily abroad in the first place as long as the parliament is willing to curtail inflationary monetary policy that rejects (classical) economics, analysts have pointed out.
Self-Balanced
Before open market operations were invented by the Federal Reserve in the 1920s, banks that issued notes (banks of issue) did not have a policy rate and balance of payments were self-correcting through the short term rates and what was then called the specie flow mechanism.
Banks that engaged in inflationary policy had to float (called a suspension of payments) or they failed (closed its doors), immediately and permanently ending BOP problems, while causing losses to note holders/depositors.
Under central banking, losses are caused to depositors of all banks including solvent ones due to depreciation.
Sri Lanka’s central bank however appreciated the currency amid deflationary policy, restoring some of the losses to depositors and EPF holders, and declining price (deflation so-called) led to a quick recovery in the economy as firms cut prices food prices eased and actual debt deflation (credit contraction) ended.
In the past, before the ‘age of inflation’, and statistical macro-economics, money was not printed deliberately to boost the cost of living (inflation targets), employment or growth, but were acts of desperation in war time with knowledge of the consequences. (Colombo/June11/2025)
