When the Reserves Slow Down: The Rupee’s Hidden Struggles

 

When the Reserves Slow Down: The Rupee’s Hidden Struggles

Referenced Article

      Title: Sri Lanka central bank buys US$781mn less to August 2025 than last year

      Published on: 15 September 2025

      Source: Economy Next

     Author: Economy Next News Desk

 

 

The foreign exchange (FX) market is at the heart of global trade and finance. It is where currencies are traded, exchange rates are determined, and confidence in a country's financial system is tested on a daily basis. In Sri Lanka, the Central Bank of Sri Lanka (CBSL) is at the central of this market selling and buying US dollars to manage liquidity and build reserves.

But in 2025, official data tell a story of slowdown: the CBSL has been buying fewer dollars this year compared to last. What does this mean for the rupee, and why should we care?

The Figures Behind the News

In August 2025, the CBSL purchased US$142.5 million from commercial banks, states EconomyNext. Over the eight months of January to August, the total figure is approximately US$1,238.6 million

Here's the catch: for the duration of the same period last year, the CBSL had purchased over US$2020.4 million. That means in 2025, the bank has purchased down by US$781 million. This is a decrease of nearly 40%.

At first glance, this is a small accounting change. But it's not an oversight or a flaw in the market. It's a conscious policy choice. In the FX world, it's a red flag.

The drop in dollar purchases reflects two distinct monetary periods:

• ·       2024: The CBSL pursued deflationary policy drawing money tight to hold down        inflation and stabilize the currency. This allowed aggressive dollar construction without stimulating price pressures.
• ·       2025: The central bank has been trending towards accommodative operations, including open market activities that actually infuse liquidity into the system.

This change is linked with a revival in private credit a positive sign for growth but a complication for reserve accumulation.

 

The Debate on Sterilization: Is Unsterilized Purchase a mistake?

One of the most significant technical shifts was in 2025: the CBSL's dollar purchases are no longer sterilized. That is, the rupees injected into the system when purchasing dollars are no longer matched by the sale of government securities.

Why it matters:

Supporters maintain unsterilized purchases simplify reserve accumulation and reduce interest costs. But critics warn the move poses a threat to inflation and exchange rate pressure especially if liquidity expansion is not supported by deflationary restraint.

The action has been dubbed a "mistake" by one analyst quoted in the report. If money supply expands too rapidly, the resulting inflation could undermine the very stability the reserves are intended to ensure

The Current Account Conundrum

The 2025 experience discredits the simplistic belief that "current account deficits lead to currency depreciation." Even when Sri Lanka had a surplus, the rupee depreciated.

This undermines an earlier belief by the majority of mainstream economists that current account deficits are the primary source of currency weakness. It suggests monetary policy credibility and not trade balances could be the actual pillar of exchange rate stability.

As EconomyNext’ columnist Bellwether argues:“Blaming current account deficits is a convenient excuse for the macroeconomist to escape accountability.”

History's Warning: Are We Repeating the Same Mistakes?

The monetary history offers a sobering lesson. The Central Bank of Ceylon, the predecessor of the CBSL, retained stability for its initial 18 months through deflationary policy. That discipline was soon lost, establishing decades of crisis on an episodic basis.

Now, with Sri Lanka navigating the later stages of an IMF program, the risk is increasing. The report warns:

“That is why in the latter stages of a 4-year IMF program now some countries miss targets and there are street riots as currencies slide again.”

The drop in dollar purchases can be more than a strategic choice it can be a sign of the same institutional habits that caused previous failures.

Personal Analysis

In my perspective, the CBSL's reduction by $781 million of dollar buying is much more than a shift in reserve accumulation approach. In my view, the central bank is trying to do two difficult things at the same time. On the one hand, the central bank is trying to stimulate economic growth by allowing more liquidity into the banking system. on the contrary, it must guard against reigniting inflation or devaluing the rupee.

What impresses me is the unsterilized nature of recent interventions. While the policy has the benefit of keeping reserve accumulation low and reducing near-term fiscal burdens, it is fraught with the risk of stimulating money supply growth at a moment when private credit is on the rise. Such may create a vicious feedback process increased liquidity could create import demand, which would squeeze the current account, and even lead to rupee weakening just what reserve accumulation is attempting to prevent.

I also find the disconnect between currency performance and current account surpluses particularly interesting. It contradicts the received wisdom that it is trade balances that determine a country's currency strength. Rather, it highlights the significance of monetary credibility the confidence the market places in the central bank sticking to price stability. Without this confidence, even a surplus will not protect the rupee from weakness.

History is heavy in this instance. Sri Lanka's monetary institutions have a long tradition of prioritizing short-run growth over long-run stability, time and again with dire consequences. That the CBSL is being faced with this choice again during an IMF program and fragile public confidence suggests that structural drivers of monetary instability cut very deep.

In my view, the CBSL's current strategy is between a rock and a hard place. If applied with accuracy, it may help recovery without undermining stability. But if there is lack of discipline, Sri Lanka may end up doing things all over again where good intentions resulted in inflation, currency depreciation, and street unrest. The next few months will be the moment of truth for whether or not the central bank is able to break this cycle.

 

 

✍️ Written by: Divya Nethranjali

📅 Published on: September 19, 2025