ECONOMYNEXT – Sri Lanka’s forex markets are hamstrung with moral suasion with no active spot quotes, market participants said, replicating conditions seen in past episodes of currency trouble after credit driven by central bank re-finance.
There was also no active spot-next market though there were some quotes over the week.
Interventions were seen around 317.00 on Thursday and 317.75 later.
Perhaps the only market rate is a one month forward of around 319.00/70 to the US dollar, market participants said, implying a spot rate of around 318.10 to the US dollar.
Here we go again
The hamstrung market replicate conditions seen in previous episodes of money printed by the central bank to keep rates down, and convertibility was denied (refuses to give dollars to newly printed money that turns into imports through credit) through ‘exchange rate as the first line of defence’ until confidence is killed and market is driven to panic with exporters holding back and importers covering early.
Printing money by either open market operations (monetizing domestic assets of banks or new treasury securities), fx swaps (monetizing foreign assets of banks), and denying convertibility, violates the ‘price specie flow mechanism’ of Hume (applied to dollar reserves instead of specie) is the reason why currencies of reserve collecting central banks collapse.
The central bank partially defended the peg and provided convertibility to Treasury rupees to repay debt, providing some protection to the currency through unsterilized sales, but not to private citizens, leading to steady depreciation of the rupee over 2025.
RELATED : Sri Lanka central bank makes over $750mn unsterilized forex sales to govt
To prevent the new rupees from hitting the forex market through credit, the liquidity has to be extinguished by the central bank though sell downs of its domestic assets, whether the the new rupees come from dollar purchases or swaps.
Analysts had also urged the central bank to terminate the swaps and mop up the liquidity to prevent forex trouble and lock-in reserves bought outright.
RELATED : Sri Lanka should terminate CB swaps, lock in foreign reserves bought outright
In addition to printing through buy-sell swaps, the central bank also bought dollars ruthlessly preventing appreciation in February (monetized a balance of payments surplus) as cyclone Ditwah slowed credit, unlike in 2004 and 2005 when a tsunami reduced credit and the rupee was allowed to strenghten, analysts have said.
Unsterilized dollar purchases, without running sufficient deflationary policy (permanently mopping up the new rupees created to lock in reserves) weakened the rupee, while purchases of dollars at each fall of the currency aggressively signalled to exporters to sell dollars at depreciated rates.
Warnings ignored, Hume rejected for econometrics
Analysts who had tracked the previous actions of the central bank after printing money through open market operations, and denied convertibility, had warned over recent months that the practice destroys confidence in the currency which it is supposed to produce and safeguard the value.
There have been increasing calls over the past year to bring laws to restrain the central bank’s leeway to print money through various tools and deny convertibility, as analysts saw the monetary authority push the rupee below 305 to the US dollar, aggressively deploying exchange rate policy against the national currency in which it has a monopoly.
The action of the central bank has been described by analysts as the ‘political ravishment’ of the rupee, before current problems in the fx market emerged.
Analysts warned that a pick up in credit will lead to external trouble.
The rupee was pushed down through aggressive exchange rate policy and swap liquidity amid an external current account surplus.
RELATED : Sri Lanka’s exchange rate depreciation by ‘Political Ravishment’
<i>THE FLAW : The fall of the rupee in 2025 has exposed flaws in the operating framework of the central bank and Mercantilist claims on current account deficits.</i>
Macro-economists have long blamed external current account deficits and also budget deficits for external trouble after cutting rates with inflationary policy.
But depreciating the rupee through flawed operating frameworks (targeting money supply without a floating exchange rate) made it impossible to run budgets, especially from the 1980s, after the IMFs Second Amendment to its articles left the country without a credible anchor.
In 2026 the rupee is falling despite steep contractions in the budget deficit almost to surplus status.
Analysts have pointed out that flexible inflation targeting without a clean float is a seriously flawed operating framework that has led to forex trouble and eventual default without war, Latin American style.
Since the central bank creates money when foreign exchange is purchased, the action also leads to depreciation through the credit system unless the money is given to the Treasury immediately mopping up the excess liquidity or the peg defended by returning dollars to owners of the new rupees.
Instead, to prevent the next default, the Treasury should buy its own dollars to create a sinking fund to service debt, ending the monopoly of the central bank as the supplier of dollars for debt repayment, analysts have pointed out.
Debt Trap and Feudal Priviledges
Whenever it runs inflationary policy for extended times, a central bank loses the ability to collect reserves as the currency comes under pressure. The Treasury then has to borrow dollars through budget support loans or through domestic dollar bonds or other borrowings, including to repay interest.
The Treasury issuing domestic dollar bonds to banks – while pushing the central government into a debt trap – will not create new money unlike central bank fx swaps.
The central bank also has a feudal era privilege called ‘government acceptance’ which blocks the Treasury from charging taxes in foreign currency.
Both monopolies force the Treasury to borrow dollars instead of purchasing or taxing, putting the country into a debt trap and potential default unless the central bank is prepared to run deflationary policy to collect reserves without expanding reserve money.
As a result, as long as the central bank cuts rates and de-stabilizes the exchange rate with inflationary policy, the Treasury could default even if it runs a budget surplus, despite people paying taxes through their noses as the monetary authority’s monopolies and privileges block non-debt fx streams to the Treasury.
The central bank’s depreciation of the rupee through denied convertibility to its note-issue also internalizes the Middle East crisis and undermines the credibility of government policy by inflating import prices of fuel as well as all foods.
In 2018, the central bank engaged in similar policy, including through monetizing Hambantota Port lease proceeds through buy-sell swaps, discrediting the economic agenda of the then administration with exchange and trade controls and depreciation, despite tax hikes and market pricing of fuel.
RELATED : Sri Lanka controls imports in ‘Nixon-shock’ move to protect soft-pegged rupee
As money was printed under ‘flexible inflation targeting’ and the rupee depreciated under ‘exchange rate as the first line of defence’ made an administration that came with promises of free trade to end up with egg in their face, as Nixon-shock style external controls were imposed.
The central bank first undermined and discredited a democratically elected government after triggering forex troubles from February 1952 with inflationary policy. In the first 18 months or so of its existence, the Ceylon central bank outperformed most Sterling area authorities by running deflationary policy.
RELATED : Will Sri Lanka’s central bank do a Dudley to Anura with rupee depreciation?
The first ‘aragalaya’ followed, as stabilization policies and tax hikes were deployed. The Prime Minister resigned and the administration was defeated in the next election amid a a rise in nationalism.
Destroying wages and the EPF
Analysts have also pointed out that it is not fair for the central bank to depreciate the currency, push up food and energy prices, nullify small increases earned by wage earners last year as the economy recovered and to destroy value of their Employees Provident Fund, while giving its own staff high salaries.
RELATED : Rejoicing as inflation target, depreciation batter Sri Lanka’s poor, is immoral and in is bad taste
Countries with monetary authorities with no policy rate like in Singapore, have avoided political instability and social unrest and maintained the value of worker provident funds, preventing the destruction of capital in general by avoiding depreciation.
“For our workers, high inflation erodes the purchasing power of their salaries, eats into their Central Provident Fund (CPF) balances, and discourages savings,” Prime Minister Goh Chok Tong said at the 25th anniversary of the Monetary Authority of Singapore which has rejected inflationary policy.
“Fortunately for Singapore, our inflation rate has been low and our currency strong.
“Low inflation has preserved the real value of our CPF savings and protected our purchasing power.”
(Colombo/Apr24/2026)