ECONOMYNEXT – Sri Lanka’s central bank has settled debt of 900 million US dollars to the Reserve Bank of India, and another 209 million US dollars to the International Monetary Fund, during the year to March 2025, official data show.
Reserve Related Debt
The central bank borrowed around 2.2 billion US dollars from the RBI through the Asian Clearing Union, and also took a 400 million dollar swap during the currency crisis triggered by the 2019-2020 rate cuts and liquidity injections.
Once private credit has picked up, any reserve sales made for imports out of central bank swaps or ACU borrowings trigger more money printing to sterilize interventions delaying a correction to the system.
Dollars borrowed from foreign central banks or other swaps allow a monetary authority to delay rate corrections, and build up imbalances between credit demand and supply of savings which then require large rate hikes to correct, especially if confidence in the currency has been lost in the meantime.
The ACU credits and the 400 million dollar RBI swap was converted which Sri Lanka’s central bank has been settling since the fourth quarter of 2023 at the rate of around 75 million dollars a month.
Out of the 2,451 million dollars of RBI dues in the fourth quarter of 2023, about 1,326 million remained by the end of the first quarter of 2025.
IMF Debt
The central bank is also settling an IMF loan taken after the crisis triggered from 2015 inflationary rate cuts under so-called flexible inflation targeting, or a statistical framework where claims are made that historical inflation in the past 12 months allows rates to be cut in the present time.
In the year to March 2025, the central bank has settled 209 million US dollars to the IMF, or reserve related debts totalling 1,109 million dollars.
About 663 million dollars remained of the 2015/6 currency crisis loan. The central bank has a swap with the People’s Bank of China, which the agency fortunately did not allow the central bank to spend and get into further trouble.
However an additional allocation of special drawing rights given by the IMF, was also busted to keep rates down and pay for imports or repay debt.
Under the current program, IMF loans are given to the Treasury.
The settlements of reserve related debt, have allowed the central bank’s net foreign assets, which were negative by around 4.6 billion US dollars at the height of the crisis, to improve.
By keeping domestic policy rates at an appropriate level the central bank can buy outright dollars in the market, and also sterilize them (mop up the liquidity created by the dollar purchase), by selling down domestic assets to banks (deflationary policy).
Fiscal Obligations?
The central bank also has obligations to provide dollars to the government to settle loans, which also require deflationary policy to collect reserves.
Analysts have warned that flexible inflation targeting is an operating framework based on spurious monetary doctrine and interest rates of a reserve collecting central bank has to depend on its actual financial obligations.
The central bank also appears to have at least a de facto obligation to give dollars to the central government to settle loans.
RELATED : Sri Lanka central bank makes over $750mn unsterilized forex sales to govt
Sri Lanka’s central bank had a mechanism under its old law which allowed the agency to provide dollars to the government without disturbing rupee reserves of the banks (an effectively reserve money neutral system) but it appears to have lost the process under the current law.
The central bank can broadly meet most of a net international reserve target of the IMF program by collecting enough dollars outright to simply settle its own obligations.
However, if rates are too low, it will not be able to generate enough dollars outright.
Concerns have been raised that the central bank will not be able to generate enough dollars outright to settle its debt and also provide dollars to the government to avoid the next default if rates are too low and domestic private credit is too strong.
Sri Lanka gross reserves have failed to improve from around October 2024, when large amounts of money was printed to jettison a scarce reserve regime, but net assets continued to improve with dollar collections.
The central bank appears to operate a scarce reserve regime again up to August 2025, which allows reserves to be collected, but questions have been raised whether the current rate structure allows sufficient dollars to be bought outright.
In June, data showed that net foreign assets also fell, materially.
RELATED : Sri Lanka central bank net foreign reserves fall over US$100mn in June: Analysis
If the central bank is unwilling to run sufficient deflationary policy to collect reserves, the Treasury will have to buy its own dollars, analysts have said.
Under the current program the Treasury is now responsible to repay IMF debt as well, adding a new risk to the Treasury if it depends on the central bank running deflationary policy to collect dollars.
Unsterilized Purchase, Unsterilized Sale
Up to June, around 770 million dollars have been provided to the government for cash, which led to the extinguishing of excess liquidity (unsterilized sale of dollars) in money markets automatically balancing the system.
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Sri Lanka central bank makes over $750mn unsterilized forex sales to govt
Sri Lanka Treasury should buy its own dollars to settle debt and avoid second default
However any reserve sales to the government which leads to off-setting liquidity injections in the future to keep interbank rates down, would have a negative effect on future reserve collections.
The central bank bought 256 million US dollars from forex markets in May which was a good number, but only 112.2 million in June and 81 million dollars in July. Sri Lanka has to keep a close eye on the reserve trends in the next two to three months, analysts say. (Colombo/Aug27/2025)
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