ECONOMYNEXT – Sri Lanka’s central government debt edged up to 96.7 percent of gross domestic product by March 2025 from 96.1 percent in December amid some currency depreciation, official data showed.
Central government debt went up to 29,258 billion rupees in the first quarter of 2025 from 28,739 billion rupees, central bank data showed.
Domestic debt went up from 18,310 billion rupees to 18,532 billion rupees, while foreign debt went up to 10,722 billion rupees, from 10,429 billion rupees, faster than the budget deficit of the period amid some rupee depreciation.
Sri Lanka operates a so-called flexible exchange rate, an intermediate regime fraught with anchor conflicts, which is neither a clean float nor a hard peg and is prone to instability when private credit picks up.
Sri Lanka defaulted in peacetime, while operating a similar regime and printing large volumes of money to target a mid-corridor (singe policy rate) interest rate, as well as some signaling analysts have shown.
Peacetime defaults proliferated after the International Monetary Fund’s second amendment to its articles in 1978 left many countries without a credible anchor for central banks, while unsound money became a policy tool under so-called ‘competitive’ exchange rates (basket-band-crawl policy).
East Asian export powerhouses rejected the ideology and Singapore, Taiwan and Japan appreciated the currency in the late 1970s while Malaysia also kept the line.
Sri Lanka’s post 1978s economic liberalization plan also got mired in depreciation, high inflation and social unrest and was publicly discredited as macro-economists denied monetary stability for what was one of the most reformist governments in Asian history.
Sri Lanka’s central bank has operated broadly deflationary policy since the third quarter of 2022 providing sound money in classical economic terms, allowing growth to recover and improving public confidence in government policy.
However there has been warnings that the central bank is skirting on thin ice with the latest rate cut and further rate cuts may make it difficult to repay foreign debt as happened after 2015.
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Analysts have warned that printing money in the last quarter of 2024 to target a mid corridor rates (rates went up due to a pick up in private credit) and the last rate cut as bank deposit rates went up, are red flags.
When private credit picks up, banks have tended to pay less attention to government debt in the past.
Sri Lanka Treasury should buy its own dollars to settle debt and avoid second default
Sri Lanka usually triggers currency crisis not due to budget deficits per se, but due to the unwillingness by the central bank to allow Treasuries yields to move up when private credit recovers, leading to monetizing debt, not just from current budgets, but maturing securities from past deficits, analysts have shown.
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This week a Treasury bill auction failed to be fully sold but there were more subscriptions on tap. The rejection of securities is a also type of ‘signalling’ mechanism which is bound to fail when private credit really picks up fail.
Analysts have also pointed out that it is not really possible to manipulate gilt yields for a ‘transmission mechanism’ with a ‘domestic buffer’ when private credit recovers.
While people will pay taxes to improve government finances, currency collapses leads to repeated defaults in Argentina in part due to technical assistance given to operate intermediate regimes, rejecting classical economics.
The Bretton Woods system also collapsed due to the same reason. (Colombo/July26/2025)
