ECONOMYNEXT – Sri Lanka’s inflation measured by consumer prices in the capital Colombo rose 3.0 percent over 31 months since monetary stability was restored in September 2025, official data showed while 12-month prices deflated.
The Colombo Consumer Price Index grew 0.8 percent in the May to 192.8 points, though it was down 1.2 percent over 12 months.
In May 2025, the food price index surged 2.7 percent, reaching almost to the monetary crisis levels seen in late 2022.
Food prices surge due to seasonal factors in Sri Lanka due to them being largely non-traded, but they could be accommodated by the prevailing monetary framework. In April reserve money tends to surge due to monetary accommodation of state salary advances (in the past) and dollar conversions.
Sri Lanka’s central bank is targeting a five percent increase in the cost of living each year, which requires non-traded food prices in general to be pushed to high levels, with the US Fed also not creating inflation with more prudent monetary policy compared to two years ago.
The central bank can also reach its high cost of living target by depreciating the currency and undermining the salary gains made by the people over the past year and pushing up traded foods and energy prices.
The central bank has kept excess liquidity high in money markets, after running out of Treasury bills to sell and collect foreign reserves.
Though the excess liquidity, mainly from outright purchases of US dollars can result in imports when banks re-lend them to customers, putting pressure on the exchange rate, if the central bank does not intervene in forex markets after generating the new money.
In May the central bank also cut it policy rates, and its floor rate is now only 25 basis points above 7.0 percent upper limit of its inflation target and the mid-corridor rate is now at 7.75 percent.
The operating framework has triggered serial currency crises since the end of a civil war as rates were cut by printing money mostly through open market operations, including when politicians raised taxes to reduce deficits.
The latest rate cut has come without printing money, with analysts pointing out that overnight policy rate was signalling rates up by undermining the workings of the interbank money market.
But the single policy rate (or mid corridor rate) can also undermine the workings of the interbank market as money is printed to suppress the rate with liquidity injections, undermining a scarce reserve regime, as was seen in currency crises in 2012, 2016, 2018 and 2020/22, analysts have said.
Concerns have been raised that due to unsterilized interventions (no deflationary policy in 2025) after the central bank ran out of T-bills to sell, the three-month rates may be below what is required to finally generate reserves to repay debt.
Sri Lanka also operates ‘flexible exchange rate’, which critics say is a notoriously unstable exchange regime with anchor conflicts and no credibility, found in defaulting IMF-prone countries.
Debt repayments require a real transfer of capital from banking system, crowding out domestic credit at a given exchange rate.
Since the Treasury does not independently buy dollars to repay debt, it has to depend on central bank to run deflationary policy in conjunction with a de facto exchange rate peg.
The central bank itself owes money to the IMF and India, which also require deflationary policy and a de facto peg to generate reserves to pay back. (Colombo/May31/2025)
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