Sri Lanka’s Foreign Reserves Edge Up in August 2025, But Risks Remain

Source - Central Bank Of Sri Lanka

Gross official foreign reserves in Sri Lanka rose to USD 6.17 billion in August 2025, a small improvement of USD 19 million as per Central Bank data as compared to July. This growth, though an improvement, is not fast enough to fund external debt repayments in the future and keep the currency stable.

Liquidity Preference Theory In Action

The current monetary policy of Sri Lanka relates to the theory of Liquidity Preference as postulated by Keynes. To keep interest rates low, the Central Bank has been adding huge volumes of liquidity since October 2024 under an abundant reserve regime.

Keynes believed that with an increase in liquidity, interest rates would decrease and borrowing would become less expensive, consequently triggering short-run economic growth. This caused an increase in credit demand and expenditure in the Sri Lanka scenario.

Nevertheless, the flood of money also boosted imports demand, spurring dollar outflows and reducing the rate of reserve accumulation. In spite of a growing economy, reserves decreased by USD 306 million since October 2024. The cause of this is that unless the liquidity is squeezed with a deflationary policy, economists fear that the Central Bank will not be able to stabilize the rupee and accumulate reserves.

Policy Problems and Slow Progress

Source - Google

Despite efforts to increase growth, Sri Lanka's monetary policy faced some challenges. In early 2025, officials reduced part of the liquidity, permitting purchase of some dollars, although little has been achieved. Worsening the situation, the Central Bank extended USD 770 million to the government during the first half of the year that financed what analysts indicate ought to have been directly raised by the Treasury to circumvent inflationary pressures.

IMF Support and Future Outlook

This is due to the fact that the International Monetary Fund (IMF) is offering technical assistance to improve liquidity forecasts and reserve management. The question is, however, when the changes in policies will be implemented.

Although Sri Lanka is expanding its economy at a rate higher than 3 per cent and higher than its estimated potential output, there are threats. In case the demand in private credit grows and the Central Bank remains in its present position, its accumulation of reserves may also become stagnant, which would put pressure on the exchange rate and dependent sectors related to imports.

To establish long-term stability, we need:

• An even more aggressive deflation plan to accumulate reserves on a quicker pace
• Increased Treasury buying of dollars.
• Coordinated monetary and fiscal policy to avoid default.

In this critical point of departure Sri Lanka needs to create a balance between economic growth, stability of the currency and debt, a task that needs a disciplined implementation of policy and careful counting of reserves.

Written by – Hirushan Godagama

Original Article – ‘Sri lanka's foreign reserves US$6,166 MN in August'

Publication date – 06 th september 2025

Source - economynext.com