ECONOMYNEXT – Sri Lanka has undertaken to buy around 2.5 billion US dollars from forex markets over the next 11 months under an International Monetary Fund program to build foreign reserves.
“We are gradually rebuilding gross international reserves including through outright FX purchases in the market, supported by a non-interest current account surplus, new external financing and other non-debt creating inflows, and sovereign debt relief,” IMF program documents said.
Sri Lanka would buy 2.65 billion US dollars between November 2024 and December 2025 and 1.3 billion up to June 2026, program documents said.
From November 2024 to May 2025, the central bank had bought 1.34 billion US dollars on a net basis, which is around the level required to meet the target.
In the next 11 months Sri Lanka therefore has to buy around 200 million dollars a month.
When the central bank buys dollars it creates new money which (will push down rates) and will be used by the previous owners of the dollars or other parties they buy goods from or as credit, generating imports.
A large volume of excess liquidity remained in the market into the second quarter.
The central bank has to mop up the rupees through deflationary operations (sell downs of central bank held securities) to mop up the new rupees, at a required interest rate, to keep credit in balance and lock in the reserves.
Either a resumption of inflationary open market operations like in late 2024, which drive bank credit beyond available savings, or rate cuts which will drive up private credit faster or discourage savings and drive consumption, will make it difficult to buy dollars if interest rates are too low.
The reserve target expressed as Net International Reserves should go up from 322 million dollars to 949 by end June 2026 (after meeting central bank and other debt repayments).
Under the new IMF program up to end June 2026 there is no longer a requirement to sell down the central bank’s Treasuries bill stock significantly and no bar on engaging in new swaps with domestic market participants to show borrowed reserves.
There are however interest coupons due from the Treasury to the central bank on its bond portfolio which is deflationary. Last year it amounted to 300 billion rupees (about a billion US dollars).
Any attempt to buy extra dollars which are not matched by deflationary policy will lead to a depreciation of the currency, as well as rises in food and energy prices, as in the past and IMF countries that have riots by the eight review, analysts say.
Any dollars sold against cash to the government to settle debt is also deflationary if the sale is unsterilized.
But under a single policy rate, which is low, the central bank may end up offsetting them with new money (sterilizing), leading to reserve targets being missed, analysts have warned.
Sri Lanka’s central bank has a reserve target – which requires external anchoring – but the program is monitored by a monetary policy consultation clause in terms of inflation, something that the IMF started in 2014. The two QPC represents anchor conflict and rejection of classical economics, especially if the cost of living hiking target is high, analysts have said. (Colombo/July15/2025)
