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Sri Lanka’s private sector credit is expanding at record speed. In July alone, lending rose by Rs. 201.5 billion, following a record Rs. 221 billion in June. Over the first seven months of 2025, banks disbursed Rs. 901 billion in credit, which is nearly three times the figure during the same period last year. On a year-on-year basis, private credit grew by almost Rs. 1.5 trillion, marking a 19.6% increase. Although these figures indicate a recovery in confidence following the financial crisis and debt default, they also raise doubts about whether the current rate of growth can be sustained.
In economic theory, when credit demand rises sharply, interest rates are expected to climb as well. The Loanable Funds Theory proves that when businesses and households want more credit, they compete for the limited amount of savings, pushing rates upward. According to the Liquidity Preference Theory, when income increases, consumers prefer to have more cash on hand, which also puts pressure on interest rates. Higher borrowing costs should logically follow from increased demand for funds in both situations.
However, this typical economic theory doesn't comply with Sri Lanka's context. Despite the increase in credit, interest rates have not changed, and in many instances, they have even decreased. The Central Bank of Sri Lanka has been implementing a broadly deflationary policy since late 2022 to strengthen the rupee and reduce inflation. Through "signalling," it has lowered rates more recently, purposefully keeping borrowing costs lower than what the market would typically demand. The mismatch between theory and reality demonstrates how strong the central bank's intervention is; sometimes it is stabilising markets, but also posing unintended risks.
Are We Repeating the Same Past Mistakes?
In this context, Sri Lanka's past shoots clear and strong warnings. Aggressive money printing and continuous currency depreciation in the 1980s reduced real savings and raised uncertainty. The economy suffered from significant costs and frequent crises, loanable funds decreased, and liquidity preference increased. Although today’s deflationary stance has rebuilt trust, recent “signalling” rate cuts hint at a return to short-term fixes. The risk is that the same mistakes that could once again drag us into an economic crisis.
On the plus side, stability has begun to pay off. Investors are confident about their investments, and savers think that the value of their money will not erode because inflation is low and the rupee is stronger. Here, the supply of loanable funds has increased, and liquidity preference has decreased., This combination promotes investment and healthy expansion. But maintaining this trust while avoiding falling back to political agendas or inflationary measures is hard to tackle.
From my point of view, Sri Lanka's credit expansion is not an immediate danger. It shows investors are much more confident, and there is a healthy economic expansion. The discipline is the only thing that can keep this boom going. Credit expansion can support a long-lasting recovery if authorities maintain stability, safeguard savings, and prevent artificial liquidity injections. Otherwise, the well-known cycle of crisis, inflation, and currency pressure might recur. In simple terms, growth has been made possible by stability, but it will only continue to be so with discipline.
Written by: Senuthi Kariyawasam (Kariyawasan S.S)
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