ECONOMYNEXT – Sri Lanka’s stabilization measures were take under an older monetary law, before a new legilstion with greater Central Bank independence was enacted Governor Nandalal Weerasinghe who hiked rates, operated deflationary policy and also appreciated a collapsed currency.
Sri Lanka enacted a new Central Bank Act (CBA) in September 2023, which aimed at providing more independence to the agency, in the hope it will help maintain stability, replacing a Monetary Law Act (MLA) dating back to 1949.
“Notably, replacing the MLA with the new CBA enshrined greater independence and accountability in the new legislation,” Governor Weerasinghe said delivering an oration marking 75 years of the agency.
“However, since the CBA was enacted only in September 2023, most stabilisation measures had to be executed under the MLA.
“This underscores an important truth: even under the MLA, stability could be achieved when the Central Bank exercised its available independence with strong coordination with fiscal authorities.”
Governor Weerasinghe has delivered monetary and exchange rate stability, and stopped inflation in its tracks as if the country dollarized, from around September 2022, only partly helped by better US policy.
The stability has provided a a strong foundation for people to pick up their broken lives, which were broken by previous rate cuts.
Exchange rate stability means the Sri Lanka rupee is at least as strong as the US Fed notes, and it is a store of value and a standard of deferred payments, internally as well as externally.
This is an attribute the rupee had for almost a century until 1978 (and other currencies had for around 200 to 300 years) though the anchor shifted from silver to gold and to the US dollar from an original Indian rupee/Sterling.
There are concerns that Sri Lanka’s monetary stability will be temporary and the depreciation/inflation cycle that had worsened from 2012 in particular (the rupee fell from 113 to 300 during the period), once policy is loosened or the rupee is depreciated amid a strong credit recovery to ‘reflate’ the economy to a 5 percent target agreed with the last government.
“The Ministry of Finance shares responsibility for setting the inflation target jointly with the CBSL,” Governor Weerasinghe said.
“If no agreement is reached, the Cabinet of Ministers determines the target to be achieved by the CBSL.”
There have been concerns that said that the 5 percent target does not amount to a credible anchor, and also that true inflation targeting is not possible due to the obligation by the central bank to collect foreign reserves and also give reserves to the government to repay debt.
Some critics have also said that independence in Sri Lanka and also in the US, has simply meant discretion not rules, as was seen in the 1960s ‘reflation’ to boost employment by the Fed and the post 2000 wanton reflation for the sake of inflation that led to the housing bubble and subsequent abundant reserve regime.
If there are central bank officials who believe that they can close an output gap cutting rates with open market operations, a reserve collecting central bank will default on its notes issue (depreciate) and the government on its external debt (in more extreme cases domestic debt as well) and commercial banks and finance companies will also default (on deposits), analysts say.
Concerns have been raised about the clause in the central bank law which not only mentions potential output but also says “the Central Bank shall take into account, inter alia, the stabilization of output towards its potential level” and not just ‘may’.
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Even countries with lower and more credible targets such as 2 percent, central bankers have no accountability and only suffer ’embarrassment’ critics have said.
Meanwhile Governor Weerasinghe said economic problems might have been avoided if the current monetary law was in effect in 2019.
“The prohibition of monetary financing could have helped keep inflation under control,” Governor Weerasinghe said.
“Moreover, the absence of Central Bank financing might have compelled the Government to avoid ill-timed and reckless tax cuts – decisions that severely damaged Sri Lanka’s external credit ratings.
“A firm commitment to price stability through a flexible inflation targeting regime would have allowed the exchange rate to act as an automatic stabiliser, curbing excessive demand pressures caused by a suppressed currency.
“These institutional safeguards could have prevented the build-up of vulnerabilities that ultimately pushed the economy to the brink.
“Instead, what prevailed was the public reprimanding of Central Bank officials by political and fiscal authorities – actions applauded by many who failed to grasp the long-term benefits of Central Bank independence.”
Governor Weerasinghe retired early, and came back when the currency collapsed in March 2022 to pick up the pieces and restore confidence in the rupee.
Critics say In Lanka fiscal authorities have tended be ex-central bankers, or those who are seconded to the Treasury who believe that rate cuts lead to growth or that excess liquidity can reduce rates for any length of time after private credit picks up. (Colombo/Aug29/2025)
