ECONOMYNEXT – Sri Lanka’s call and repo market overnight volumes have surged and rates have moved up, as excess liquidity dropped, though constrained by the controversial ‘single’ policy rate, official data show.
Both maximum and weighted average call rates move up to 7.90 percent last week, from around 7.86 last month, in a painfully slow adjustment, central bank data shows.
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Volumes moved up to 50 to 60 billion rupees, from around 30 to 40 billion rupees in September.
The call market with clean money without collateral is among to banks which have risk limits to each other.
In the repo market, which is more reflective of broader conditions, where more money can be borrowed with gilt backing with a larger number of participants, the top rate went up painfully to 7.95 percent from around 7.91 percent last month.
Call volumes hit 124 billion rupees on Thursday after hitting 124 billion last week, amid strong credit growth in recent months.
The weighted average repo rate went up to 7.92 from 7.88 levels.
The single policy rate which has a ‘signalling’ effect tends to constrain money market dealers, as can moral suasion even, if money is not printed.
Sri Lanka has a so-called single policy rate at 7.75 percent, which critics have pointed out tends to undermine interbank activity and allow imbalances to build up.
In the past a mid-corridor rate was enforced by authorities with inflationary open market operations (reverse repo and term injections) as private credit built up (from the previous crisis) triggering credit without deposits, making it impossible for the central bank to buy dollars.Ma
In 2025, the central bank had only given overnight money to banks at the ceiling rate of 8.25 percent, by operating a scarce reserve regime.
In the past pressure built up through inflationary open market operations have tended to go off like a soda-pop leading to high rates as well as depreciation.
By allowing rates to fluctuate and match deposits with credit demand early, a build-up of imbalances and balance of payments pressure can be avoided.
However Sri Lanka’s domestic interest rates have to be high enough not only to match private credit but also debt repayment needs of the government as well as IMF mandated reserve requirements.
The debt repayments tend to trigger a current account surplus at the given interest rate structure that allows dollars to be purchased.
Analysts warned that a May rate cut had reduced Sri Lanka’s buffer to make debt repayments and build reserves, and the central bank was skating on thin ice.
RELATED : Sri Lanka central bank skating on thin default ice with latest rate cut
Strictly targeting a single policy rate with inflationary open market operations will lead to a quick second default.
Operating a scarce reserve regime will reduce the risk of second default, by allowing rates to fluctuate and move up from time to time.
Pegging Obligations
It has also turned out that the central bank has de facto obligation to sell dollar to the Treasury against liquidity in a pegging operation, which reduces liquidity and stops the rupee from falling when the government uses the excess liquidity to buy dollars from the central bank.
However, if the central bank does not treat other market participants when the excess liquidity turns into imports through bank credit, the rupee will depreciate.
Analysts have warned that the ‘flexible’ exchange rate adds a further complication due to its inconsistency where uncertainty and loss of confidence is triggered.
The operating framework called a ‘flexible exchange rate’ is a low credibility peg which rejects classical economics – primarily Hume’s price specie flow mechanism – analysts have pointed out.
RELATED : What is wrong with Sri Lanka’s flexible exchange rate
When early interventions are not made to redeem some of the excess liquidity either by dollar sales or sell-downs of the central bank held Treasuries, which then weakens the currency, importers tend to cover early and exporters delay sales, putting more pressure on the exchange rate.
The rupee has depreciated steadily in 2025, despite record current account surpluses coming from debt repayments showing that oft-repeated claims by Mercantilists that current deficits led to currency depreciation is a false narrative.
RELATED :
Sri Lanka rupee depreciates amid record current account surplus : analysis
As remedies analysts have urged the Treasury to buy its own dollars at money borrowed at market rates or taxes which will lead to monetary-policy-neutral transactions.
In order to trigger a constant balance of payments surplus the central bank was also urged to sell down its bond stock.
A part of the problems with reserve collections Sri Lanka is now facing is not only coming from the May rate cut but also from the lack of a requirement in the current IMF program to sell down the Treasury bond stock which are made up of step down coupons.
The central bank could strip the coupons of some bonds and sell the coupons and the principle as deep discount bonds, EN’s economic columnists says.
Under the flexible inflation targeting, Sri Lanka has tended to run into currency trouble soon after private credit recovered. The depreciation then pushes up energy and food prices, leading to the ouster of the incumbent government.
RELATED : Sri Lanka should mandate 2-pct inflation ceiling to avert next economic crisis
As an overall solution to Sri Lanka’s economic problems, analysts have urged a 2 percent ceiling rate for inflation as targeting 5 percent inflation which will reduce the risks of default and depreciation. (Colombo/Oct26/2025)
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