AR 113187
AF/22/0917
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Evaluating the Monetary Policy Stances of the Central Bank of Sri Lanka (CBSL) in
Overcoming Economic Recession with IMF Support
Sri Lanka has faced an economic crisis over the past few years due to various economic reasons.
Sri Lanka’s recent economic crisis, peaked in 2022.That is one of the worst since the country
became independent.
Impact of Covid 19 Pandemic ,poor policy decisions ,deeply entrenched structural problems and
vulnerabilities, Heavy reliance on foreign loans are the key reasons behind this recession.
Here present a detailed description of the Macroeconomic Context,CBSL’s Monetary Policy
Response,IMF’s Role and Support Measures,Effectiveness and Challenges,Contradictions
in Monetary Policy Goals and Policy Recommendations
Macroeconomic context:
●​ There were some ups & downs in SL’s economic growth until 2018,but there is a
consistent growth that can be seen.However ,due to Easter attacks in 2019,GDP recorded
a negative figure.In 2020,it is reported as -4.6 due to both post attack situations & corona.
But with the policies implemented by the CBSL,SL was able to recover again in 2021
which recorded 4.2% growth.However especially due to the poor policy implementation
and other reasons the economy contracted by 7.3 in 2022.But with the expansionary
policies introduced in 2024 SL’s economy grew by 5.2%.
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●​ There was some kind of clear inflation in Sri Lanka until 2021, but the post-corona
situation in 2022 led to an unprecedented increase, leading to hyperinflation. We also
experiesed inflation at unprecedented levels ,recording the large increase in price level.
However in late 2022,inflation started moderating from its peak-levels (69.8% in Sep
2022)showing a disinflation process.By implementing contractionary policies bring back
inflation to the target level according to FIT.
●​ With monetary policy easing, the policy interest rate was reduced by 250 basis points on
five occasions in 2020.However, the economy's interest rate was raised in 2021 and in
2022. It was raised by 700 bps, which is also reported as its maximum value.Interest
rates were increased multiple times.Because of the accommodative policy, in 2023 &
2024 rates were reduced again with the stability of price.
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●​ The government's manipulation of the
exchange rate led to an appreciation of the rupee
until mid-2022, the dollar's value was released as a
result, reaching an all-time high by mid-2022.SL
Rupee had depreciated by 45% in 2022.But in2023
flexible ex.rate regime allowed to determine ex.rate
by the market.It is lead to an appreciation of the
rupee.
●​ Since the past, Sri Lanka has been experiencing a budget deficit due to the expenditure
exceeding income, but it is reported to be at its highest level in 2022. In 2022, income
was eight and two percent, but expenditure was ten and two percent, and the total fiscal
deficit was one hundred and thirteen. It is reported to be a higher figure than even the
previous year.Government Revenue 8.2% of GDP Government expenditure 18.5% of
GDP Government debt 113.8% of GDP Overall fiscal deficit 10.2% of GDP.
13_Box_01.pdf
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CBSL’s Monetary Policy Response:
interest rate adjustments
Because of the bombing attack economic activities were contracted by the2019. The government
took steps to restore the economy and implemented policies, in which the policy interest rate was
repeatedly reduced.
The government's introduction of a large-scale concessional loan scheme under the low rates and
the reduction of the SDFR and SLFR by 500bps led to in the money market.
In 2020 SRR was reduced by 300bps,policy rates reduced by 250bps,and bank rates reduced by
650bps.Policy interest rates were reduced to 8.50%.
The interest rate has been decreasing under the same accommodating Monetary policy that was
carried out until August 2021. Rates have fallen historically to encourage borrowing &
spending.However, soon after with the contracting Monterey policy carried out by the interest
rate increased.
In August 2021 CBSL began tightening its policy .
Interest rates were increased significantly.By April 2022 SDFR & SLFR increased by 700
bps.which is a highest single- day adjustment in ever.
In 2023,rates were reduced again under accomadative monetary policy.
The policy interest rates were reduced by a total of 650 bps over 4 occasions during the year.
Considering the somewhat sluggish downward adjustment in overall market lending interest
rates, caps on interest rates of selected lending products were imposed.
Monetary Policy | Central Bank of Sri Lanka
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liquidity management
Through SRR & OMOs CBSL managed liquidity.in 2020, monetary easing was carried out
extensively.In order to increase funds and increase liquidity in the financial market, the SRR was
reduced to 4% in March 2020. This created an additional liquidity of Rs. 180 billion in the
money market.
Under the OMO, the CBSL purchased about Rs. 625 billion worth of T-bills from the primary
market in 2020. The reduction in SRR, the purchase of securities from the primary market, and
the purchase of dollars from the exchange market by the CB led to an increase in liquidity in
2020.
In 2021 ,CBSL reducing SRR by 200 bps feeds more money to banks to lend.
Soon after from mid 2021 CBSL raised SRR to absorb excess liquidity from the banking
system.,Monetary tightening reduced the availability of funds.OMO used to absorb liquidity as
needed.
Overnight liquidity at the end of 2021 - Rs.366.3 billion
In 2022,still tightened the monetary policy stance,Money market liquidity was allowed to be
maintained at deficit level.
CBSL purchased t-bills to support the government's needs and returned funds to the banking
system in the face of high deposit interest rates, resulting in a large-scale reduction in liquidity
levels.
The Central Bank’s monetary policy stance in 2023 saw a gradual transition from the significant
tightening of monetary policy in 2022 to an accommodative stance in the latter half of 2023.
SRR cuts from 4% to 2% on average injecting Rs.200 billion into the market. OMO’s were
address liquidity shortage.The Central Bank also conducted active OMOs injecting liquidity on a
term basis through term reverse repo auctions as needed in addition to the overnight reverse repo
auctions.Banks were reduced lending rates by at least 30 bps.
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Foreign exchange policies
The enactment of CBA reiterated the importance of a flexible exchange rate regime to
complement the FIT framework. According to CBA, the Central Bank is charged with 82
reveiew of CB polciesvwith the implementation of a flexible exchange rate regime in line with
the FIT framework in order to achieve and maintain domestic price stability.
In the first half of 2021 and 2022, the government maintained a fixed exchange rate to maintain
the SL rupee at a stable level. But the exchange rate did not appreciate as expected.However, this
adjustment fell short of expectations due to the large overshooting of the exchange rate.
Accordingly, the SL rupee depreciated significantly by the end April. Due to this instability, the
CB commenced providing daily market guidance to the interbank foreign exchange market from
13 May 2022 onwards that helped stabilise the exchange rate from significant intraday volatility.
Followed a flexible exchange rate regime during most of 2023. The CBSL allowed greater
flexibility in the determination of exchange rate with effect from 07 March 2023 by
discontinuing the daily guidance given to the market since May 2022, considering the
improvement in the liquidity in the domestic foreign exchange market.
The exchange rate was allowed to be determined based on the demand and supply conditions in
the domestic foreign exchange market .CB aimed at preventing any excessive volatility in the
exchange rate and accumulating GOR through purchases of foreign exchange from the market.
The exchange rate appreciated against the US dollar by 12.1 in 2023 and by 7.6 %by end March
2024 .These developments enabled the CB to purchase, on a net basis, US dollars 1.7 billion in
2023 and around US dollars 1.1 billion during the first quarter of 2024.
Credit regulations
CBSL implements several credit regulations as policy. These include introducing concessional
loan schemes(I.Rate4%), such as the Saubagya COVID-19 Renaissance Facility The CBSL also
imposed, revised, and later removed interest rate caps on specific lending products and foreign
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currency deposits.Limits on Standing Facilities: Effective mid-January 2023, the CBSL
implemented regulatory actions limiting the availability of its Standing Deposit Facility (SDF)
and Standing Lending Facility (SLF) to Licensed Commercial Banks (LCBs)
Tight monetary conditions and high market interest rates contributed to a contraction in credit
extended to the private sector, particularly from mid-2022 onwards Conversely, Net Credit to the
Government (NCG) by the banking system and credit to State Owned Business Enterprises
(SOBEs) expanded significantly in 2022, partly due to the government's reliance on domestic
financing amidst limited foreign access and the revaluation effect of foreign currency debt due to
depreciation.
IMF’s Role and Support Measures:
Before 2022,SL had entered into numerous IMF programmes from time to time. But it has only
been able to succeed on two occasions .During the crisis ,SLneeded external assistance to
stabilize the economy.so that SL met with the IMF for the 17th time.
IMF approved the EFF as budget support to assist Sri Lanka’s economic policies and reforms
denoting the commencement of the IMF programme. The first and second installment of the
IMF-EFF totaling SDR 508 million were disbursed in March and December 2023.
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Targets and elements of the IMF-EFF programme
The EFF arrangement spans about 3 billion USD to be utilised for budget support for the
government. Also, It helped cushion supplementing the gross official reserves.
●​ Net International Reserves Target
Under NIR target EFF is to ensure that the gross foreign reserve assets increase
surpassing the liabilities and thereby maintaining NIR at positive levels .The gross
reserve level also witnessed a notable increase from US dollars 1.9 billion as at end 2022
to around US dollars 4.4 billion by end 2023.Under this target, SL can only use the funds
to increase international reserves because we were already lack of foreign
reserves.Through this, we were able to increase our foreign reserves.
●​ The Central Bank’s Net Credit to the Government Target .
Prior to the IMF programme, the CB was compelled to regularly engage in
monetary financing of the budget deficit of the Government.. One of the main
purposes of the IMF programme is to prevent any way that would enable the
Government to obtain monetary financing from the CB through.An important
reason to inflation is the Central Bank's provision of funds for government
financing activities. This program restricted the supply of money and the IMF has
instructed the CB to reduce the amount of government securities held by the CB.
●​ Continuous Performance Criteria and Indicative Targets .
The IMF-EFF programme has specified two CPCs. These include
non-accumulation of new external payments arrears by the nonfinancial public
sector and the CB and (ii) no new CB purchases of government securities in the
primary market.
●​ Primary Balance Target, Revenue, and Overall Budget Balance .
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SL has recorded a deficit in the primary account balance throughout its history.
Through this program,it was given a target to maintain the primary balance as a
surplus. It is a very important target for Sri Lanka's economic growth, as it allows
us to maintain foreign reserves and is also important for our fiscal deficit.The
Government achieved a primary surplus in 2023. The central government tax
revenue is specified as an indicative target.
IMF actions to support SL recovery
​ Financial support through EFF led to restore macroeconomic stability ,debt restructuring,
reconnect with the global economy.It helped support the government budget & rebuild
foreign reserves.
​ They send to us a target - reduce debt below 95% of GDP by 2032. It leads to debtrestructuring & rebuilding confidence.
​ Limiting the CB’s ability to finance the government with printed money.
​ Introducing the new CB ACT to strengthen independence.
10_Box_02.pdf
IMF Reaches Staff-Level Agreement on the Fourth Review under the Extended Fund Facility
with Sri Lanka
Effectiveness and Challenges:
The CBSL changed its monetary policies due to certain economic downturns. We can see the
challenges inherent in them as well as the effectiveness, based on their results.
Utilizing data and analysis from CBSL reports, it examines the impact of these policies on
inflation control, economic growth, exchange rate stability, and financial sector resilience, while
also addressing the difficulties faced.
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Inflation​
After the bomb attack, the economy collapses and an expansionary monetary policy is
implemented. As a result, interest rates decrease, the money supply increases, and credit
expansion increases, leading to inflation over the next year, driven by a demand-pull inflation.
​
After 2021,The tight monetary policy stance, combined with improvements on the supply side
and abating balance of payments pressures, helped contain price pressures towards late 2022
Headline inflation peaked in September 2022 and has been on a steady disinflation path since
then However,with the contractionary policies, inflation has once again seen a decline from its
peak to low. Through the contractionary and expansionary policies implemented from time to
time, the CBSL has been able to maintain a single-digit inflation rate of 5% according to FIT.
Also,Inflation expectations broadly followed the trend of realised inflation, in line with the
deceleration in actual inflation . Expected moderation was partly attributed to tight monetary
conditions.
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Growth
The policies and decline in production carried out during the 2019,2020 reduced economic
growth, but the expansionary policies implemented in 2021 increased production, turning
economic growth into a positive value and allowing the economy to recover. But again, in 2022,
contractionary policies and the imposition of import restrictions reduced demand and reduced
production, causing economic growth to turn negative.
But the imposition of import restrictions and these contractionary policies allowed the economy
to reap the benefits later, with the economic opening once again recording a positive value.
Exchange rate stability
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Tightening monetary conditions helped ease pressures on the external sector .
CBSL removed maximum interest rates imposed on foreign currency deposits in March 2022,
enabling a significant upward adjustment in these rates to mobilise foreign currency amidst
shortages and align with global and domestic conditions.
Moving forward, the CB continued to implement a flexible exchange rate regime while building
external buffers over the medium term to withstand external shocks. Tight monetary policy in
2022 was effective in helping to curb inflation and disinflation by reining in demand and
anchoring expectations. However, this stance also significantly constrained credit growth and
economic activity.
The subsequent easing of monetary policy is expected to support a turnaround in private sector
credit and foster economic recovery and growth in the period ahead.
Financial sector resilience.
2022 was marked by unprecedented vulnerabilities in the external sector amidst the worst BOP
stresses experienced in the post-independence economy.
Growing concerns about domestic debt restructuring caused the yields on government securities
to soar and remain at extraordinarily high levels.
2022 and early 2023, including restrictions on the usage of standing facilities effective
mid-January 2023, a notable improvement in overnight domestic money market liquidity was
observed.yields on government securities and other retail market interest rates commenced
easing gradually, thereby easing monetary conditions and narrowing the disorderly upward
adjustment in market interest rates.
AWPR dropped significantly during January-February 2023.The sources anticipate that the
financial sector performance is expected to remain healthy in the coming period with the
improved macro financial conditions.
With the easing of monetary policy, relaxation of trade restrictions, and improvements in the
macroeconomic environment, credit growth in both the banking and Finance Companies sectors
began to recover gradually in 2024.
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Policies are designed to increase access to credit, especially for small and medium enterprises
(SMEs), which are crucial for job creation and economic activity.
Banks reduce their dependence on overnight CB facilities.
07_Chapter_02.pdf
Challengers
To reduce inflation,implement increacing interest rates, reducing the money supply, and not
contributing to the financing of the government's budget deficit. Since the interest rate is high,
the private sector borrows less, and through this we see a decrease in investment. The amount of
money circulating in the hands of the people decreases due to the decrease in the money supply.
Also, since the government no longer contributes to the financing of its activities, the
government has to find another way to pay off its debts.Even though the expanntionary policy
was used to create economic growth,it clashed with inflationn,with headline inflation of 18.5%.
To stimulate economic growth,CBSL reduces the interest rate on loans, which then increases
the money supply. The amount of loans taken by the government and the private sector increases.
This creates inflation. When inflation occurs, the value of the rupee depreciates. This has a
significant impact. When the rupee depreciates, imports are discouraged and exports are
encouraged. But since credit expansion for the domestic sector cannot continue with inflation,
the domestic sector collapses.
When inflationary conditions arise, the exchange rate depreciates. In this case, the rupee
depreciates. That is, the real exchange rate increases, as a result of which imports increase and
exports decrease.Hight interest rates used to stimulate price stability which made exports
expensive & import cheaper.we demand imports more.This can affect domestic producers &
growth also the BOP.
The banking system has undergone some changes through the monetary policies changed from
time to time by the CB. With the tight monetary policies, liquidity in the banking system has
increased, which has led to problems in lending and managing day-to-day operations. Also, due
to the increase in interest rates, the cost of borrowing has increased, so people are reducing their
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borrowing, and the demand for credit has decreased. Then, the credit expansion that banks have
is lost, and the credit is reduced. Also, as more and more defaults are made, the amount of
defaulted loans is increasing. Also, some banks have had to cover some loans from their capital
cushion, which is also a problem for their resilience.Significant contradiction of activities.
Contradictions in Monetary Policy Goals:
The main objective of the CBSL is to achieve economic growth by maintaining price stability.
However, we cannot achieve this monetary stability, economic stability and the exchange rate
stability at the same time. There is a contradiction in this.A contractionary monetary policy is
needed to maintain price stability,To maintain economic growth needed expansionary policies.
To maintain price stability, there must be control over inflation. Also, to achieve economic
growth, demand must increase, which in turn increases production and employment. For the
stability of exchange rates, the value of the rupee must be maintained.
The CBSL implemented an expansionary monetary policy in 2019,2020,upto August 2021 to
revive the economy that had collapsed due to the bomb attacks. The interest rate was low. Also,
by providing concessional loans at a low interest rate, there was an expansion of credit and an
increase in the money supply, which made it impossible to achieve the objective of price
stability. This created a situation of inflation.
But with inflation rising, economic growth is set to fall significantly in 2022. Economic growth
is heading towards negative territory. CBSL aims to achieve economic growth by implementing
a contractionary monetary policy. To control that inflationary situation, interest rates are raised,
money supply is reduced, and import restrictions are imposed. In that, even if some kind of
inflation is controlled, demand is low, production is low, and employment is low. In that,
economic growth is reduced.
To control inflation and stabilize the rupee, CBSL raised interest rates and restricted money
supply.This stabilized the exchange rate somewhat, but inflation still remained high for
months.High interest rates helped the currency stabilization, but at the cost of price shocks and
slower recovery.
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Policy Recommendations:
potential alternative policy approaches that could have helped SL avoid or lessen its economic
crisis.
I suggest that a more gradual and preemptive tightening of monetary policy, including ending
direct government financing, alongside enhanced exchange rate management through a more
flexible system and building reserves, might have been beneficial and the importance of
supply-side focused policies to support agriculture and exports, greater coordination between
fiscal and monetary authorities, and improved transparency in policy communication. The
combination of these prudent and timely actions could have fostered greater economic stability.
CBSL delayed tigtening monetary policy during the crisis period.the impact was delayed because
earlier policies were too loose for long. If they had done it correctly during the Corona period,
we could have obtained them earlier because we could have stopped asking the CB for help in
financing.
Introducing monetary policy reports & used press releases to communicate.The new CB Act
proved the transparency of the CBSL, and if the CB had acted with transparency in
implementing its original policies from the beginning, the effects on public confidence could
have been somewhat mitigate
The Central Bank's procedure for handling the exchange rate should also be changed. In that
case, the CB kept the exchange rate fixed and then released it. However, during that period, if the
exchange rate had been allowed to be freely determined through the market and intervened when
necessary, it could have reduced the severe volatility.
The monetary policy of the CBSLa alone cannot act to overcome the crisis that has arisen. For
this, a specific fiscal policy and other supply-side policies must be taken together. The conditions
created through fiscal policy are facilitated by the adjustment of taxes and government spending
required by fiscal policy.
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References
*07_Chapter_02.pdf
IMF Reaches Staff-Level Agreement on the Second Review of Sri Lanka’s Extended Fund
Facility and Concludes the 2024 Article IV Consultation | Central Bank of Sri Lanka
PowerPoint Presentation
cbsl.gov.lk/sites/default/files/cbslweb_documents/publications/aer/2023/en/19_Special_Stati
stical_Appendix.pdf
cbsl.gov.lk/sites/default/files/cbslweb_documents/publications/annual_report/2021/en/14_In
fographics_06.pdf
cbsl.gov.lk/sites/default/files/cbslweb_documents/publications/annual_report/2021/en/14_In
fographics_06.pdfcbsl.gov.lk/sites/default/files/cbslweb_documents/publications/annual_rep
ort/2021/en/14_Infographics_06.pdf
Annual Report 2021 | Central Bank of Sri Lanka
Monetary Policy | Central Bank of Sri Lanka
08_Chapter-03.pdf
10_Box_02.pdf
Press_20250407_annual_economi_review_2024_e.pdfMonetary Policy Report - February
2024 | Central Bank of Sri Lanka
Exchange Rates | Central Bank of Sri Lanka
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