Sri Lanka’s rupee is now under pressure after the central bank loaded the dice against the rupee with excess liquidity from swaps and arbitrary interventions that busted confidence, while money in the war zone, protected from macro-economists, is sound as a bell.
The central bank systematically loaded the dice against the rupee from late 2024 not only using monetary policy (excess liquidity), but with the aggressive deployment of exchange rate policy at arbitrary rates against the interest of monetary stability and social cohesion.
There have been multiple warnings, including by the parliament’s Committee on Public Finance on the danger of buy-sell swaps.
There have also been warnings against purchasing dollars at increasingly depreciated rates (monetising in excess of the BOP surplus coming from deflationary effects of bond coupons and natural reserve money growth).
Instead of allowing the rupee to appreciate as the then leadership of the central bank did in 2004 after the tsunami, 461 million dollars were from the market in a merciless display of doctrinaire inflationism in February.
When the warnings on the rupee began last year, it was simply an over-purchase of dollars by the central bank.
There was no panic in the market or a loss of confidence from excess liquidity turned into credit or capital flight from rupee bonds.
Now it is different. There is a loss of confidence and massive excess liquidity. The instability comes from the flawed operating framework of the ‘independent’ note-issue bank.
The ‘Big Lie’ that drives unsound money
The big lie spread in basket case countries that go to the IMF repeatedly now is that the currency is market determined.
The basis of economics, including the law of demand and law of supply, are based on sound stable money (ceteris paribus), not positive inflation and monetary depreciation, or ‘competitive’ exchange rates, favoured by Mercantilist macroeconomists.
First of all, no money is or should be market determined. Prices of goods are market determined, not money. Interest rates are market determined.
The value of the monetary unit should be fixed based on a rule imposed on the note issuing authority (anchored), to ensure that a market economy functions, and there is social cohesion and democratic rule.
In a clean floating exchange rate regime, where the exchange rate ‘floats’ the central bank controls the value of the money purely through monetary policy and the policy rate, with a delay, it is not actually market determined as such.
In a fixed exchange rate, there is no monetary policy. The exchange rate is fixed to a low inflation currency by denying macroeconomists the chance to mis-target rates and fire credit bubbles and depreciation.
In a flexible exchange rate, the exchange rate is determined by central bank interventions (dollar purchases) as well as monetary policy (rate cuts and liquidity injections) in a mixture that can turn toxic in an instant.
In countries with permanently depreciating currencies, both exchange and monetary policy is deployed against the
people and against a legally elected government.
Both exchange and monetary policy was deployed by macro-economists against the rupee for more than a year. As multiple warnings were given, the rupee was de stabilised by the central bank systematically long before the Middle East war.
The rupee fell from 297 to 310 over 2025. The war is just the latest shock which the macroeconomist is using to internalise an external crisis and amplify its effects by making energy imports more expensive and driving a bigger wedge between the electorate and a legally elected government in the process.
A government which in fact was elected after a stabilisation crisis, necessitated by a currency crisis triggered by rate cuts, SRR cuts and swaps from 2020.
Prudence, stability, confidence: the fundamentals of sound central banking
Prime Minister Goh Chok Tong at the 25th anniversary of the Monetary Authority of Singapore (MAS)
The external value of our currency tells a similar story. In 1971, it took three Singapore Dollars to buy one US Dollar. Today, it takes just one dollar forty cents to exchange for one US Dollar. In 1971, it took seven dollars forty cents to buy one Pound Sterling. Today, just two dollars twenty cents would be enough. In fact since 1971, the Singapore Dollar has appreciated against most of the major currencies.
MAS has been able to contribute to macroeconomic stability because it takes a medium-to-long term perspective when making policy. In the 1960s, the view that central banks had to balance two potentially conflicting goals, economic growth and price stability, prevailed. Through expansionary monetary policies, governments and central banks frequently sought to boost short-term economic growth by allowing a temporary increase in inflation.
That view is now widely discredited. There is now a consensus that stimulating economic growth while tolerating higher inflation is ultimately self-defeating. Increasingly, the emphasis of monetary policy is on the long-term, to achieve low inflation, as the basis for sustained economic growth. This is what MAS has been doing.
Stimulus comes roaring back with 5% inflation – Reviving de- bunked Mercantilism
The central bank has deployed the flexible (read arbitrary) exchange rate doctrine against several democratically elected governments since a 30-year war ended.
Potential output targetting has been written into the controversial new monetary law which legalised a string of severe monetary policy errors of 2018 and has made the recent depreciation inevitable.
Potential output targetting is simply a new name for the thoroughly discredited full employment policies of the 1960s that wreaked havoc in developed and developing nations and led to the collapse of the Bretton Woods.
With the 5% inflation target, that is also what the central bank is doing now.
The aggressive drive to push up the cost of living and destroy real wages is a revival of debunked Mercantilism of the 1960s which East Asia rejected under classical economics.
Classical economist Friedrich Hayek, warned that the Cambridge economics would return despite the lessons of the 1970s.
“One of our chief problems will be to protect our money against those economists who will continue to offer their quack remedies, the short-term effectiveness of which will continue to ensure them popularity,” he warned.
“It will survive among blind doctrinaires who have always been convinced that they have the key to salvation.”
‘Exchange rate as the first line of defence’ is a more extreme version of the IMF’s Second Amendment that allows central banks to escape accountability after busting confidence in the currency.
The Yahapalana administration with Mangala Samaraweera as Finance Minister from 2018 in particular was the emblematic victim of these policies.
In 2015, then Prime Minister Ranil Wickremesinghe, under the influence of Cambridge economics (Keynesian stimulus), spoke in favour of heedless spending and by 2016 Sri Lanka was in serious trouble.
“In 2015, when we built the government, there was a collapse in aggregate demand,” then Prime Minister Wickremesinghe told parliament.
“In that situation in April we raised (state worker) pensioners’ payments by 1000 rupees, we raised state workers’ salaries, private sector salaries were raised. In this way we put more money in the hands of consumers to increase aggregate demand.”
Though the central bank depreciated the rupee with sell-buy terminations, outright purchases and other injections, it can be argued that Wickremesinghe was for Cambridge economics based on the above statement and particularly as the 100-day programme was also heedless spending.
Frequent references made by various IMF officials to ‘policy support’ is also nothing more than a label for heedless spending and inflationary rate cuts, which finally end in tears.
The Gotabaya Rajapaksa administration, which was elected in the wake of the currency collapses and stabilisation crises of 2017 and 2019, was fully in favour of boosting potential output through IMF style ‘policy support’. So it can be argued that the central bank was not acting contrary to the policies of an elected government as the administration was not interested in sound money.
The administration wanted to close the ‘output gap’ with unsound money and heedless spending. It paid the price in the electorate and was accountable.
Elected government not allowed to have sound money
However, it was not the case when Mangala Samaraweera was appointed Finance Minister.
He raised taxes to reduce the deficit and market priced fuel though he had to beg the central bank for Rs50 billion, because the Public Debt Department was under the control of macroeconomists who could block bill sales at market rates to control the yield curve.
It is ironic that ending yield curve control by the 1951 Fed leadership was the key point of contention with the US Treasury in the battle for what we now call ‘central bank independence’.
The current administration has the Public Debt Management Office under its control which could use auctions to run a market economy and give the correct price signals to gilt buyers through higher interest rates and keep the balance between savings and investments. But that is another story.
Back in 2018, central bank printed money, through aggressive open market operations, including to sterilise forex sales and monetising Hambantota port sales proceeds with buy-sell swaps.
At the time, Harsha de Silva, a junior minister asked for rates to be allowed to go up to restore a scarce reserve regime. On another occasion in a face book post he asked interventions not to be sterilised.
Having given de facto central bank independence, an administration that was keen on sound money was helpless. Foreign investors in rupee bonds were also put to flight with the ‘flexible exchange rate’ and the administration was forced to borrow abroad like no tomorrow as flexible inflation targetting created forex shortages.
The Active Liability Management Act was enacted instead of buying dollars to service debt at the required domestic interest rate structure in a display of the spurious Keynesian ‘transfer problem’.
The ‘external financing gap’ of the IMF is also based on the same spurious doctrine as the ‘transfer problem’. The gap emerges when rates are too low and too much savings are turned into domestic investments and imports.
At the time full employment policies were in full force with potential output targetting (IMF technical assistance) with rates cut on the basis that ‘fiscal policies were tight, therefore monetary policy should be loose,’ showing that fiscal correction only led to more printing.
The flexible exchange rate, which put foreign investors to flight which is probably the deadliest, anti-democratic operating framework ever devised by Western inflationists and peddled to unfortunate countries which end up in social unrest and default was also in full force.
Arbitrary, discretionary, unpredictable, un-democratic
The flexible exchange rate, (or any flexible policies whatsoever) that give discretion to a state agency is un-democratic and undermines the rule of law.
The great feature that distinguishes a dictatorship from a democracy (and indeed any long-lasting monarchy) is the rule of law.
The rule of law ensures that the government and its agencies with coercive powers behave in a predictable manner under a pre-declared set of rules.
However, flexible policy central banks can do whatever they want, intervene at whatever rate they want, and indeed make up rules as they go along – particularly under the tutelage of the International Monetary Fund.
The sudden imposition by the gazette of the single policy rate (floor system) in late 2024, with IMF technical assistance, on a country that had already defaulted due to excess liquidity is a case in point.
The parliament had no say in the single policy rate (or de facto mid-corridor system that was in effect from 2015, that behaves exactly like a floor system) including when money is printed through buy-sell swaps.
The flexible exchange rate where discretionary interventions are made at various levels of the exchange rate to push it down and expand excess liquidity, is the last word in arbitrary action of a state agency.
If there is an auction to purchase dollars, the currency will depreciate with each error made by bureaucrats in deciding the volume of purchases of the day.
If the purchase volume decided by the state official is more than the volume permitted by a balance of payments surplus the rupee depreciates, inflating all prices.
Unlike a nominal exchange rate target, where the purchases are limited to the BOP surplus (one day’s excess purchases have to be returned the following day by the intervention rule), daily state-decided volume purchase is a hit or miss.
The depreciation of the rupee shows that central bank purchases over 2025 and 2026 have been inimical to the value of the monetary unit and stability.
Each debauched rate at which the central bank buys signals to the market that the monetary unit is worth less sets off a chain reaction.
Rejecting rule of law, constitutionalism and escaping accountability
All this happens because the macroeconomist, steeped in statistics instead of economic theory, also has no conception of law, legality, constitutionalism, or parliamentarianism.
Sri Lanka’s monetary problems, which manifest themselves as forex shortages, depreciation, moral suasion and a crippled spot market which moves to spot-next, is a legal and political problem of the parliament failing to fasten a constraint on the central bank to restrain its arbitrary or flexible operating framework.
Or put in another way, the lack of true constitution to restrain the agency, which has instead been given flexible or discretionary powers, is the problem.
Sri Lanka’s central bank — as had been seen repeatedly in the past – is at risk of every inflationist fad that is cooked up by academic inflationists of the Anglophone West which then flows down as technical assistance from the IMF, creating economic mayhem.
Macroeconomists who have rejected economists (Hume, Ricardo, Smith, Say to name a few) and have instead placed their faith on statistics and inflation, have developed elaborate mechanisms to escape accountability.
The central bank has for years escaped accountability for monetary mis-governance and arbitrary interventions— including surrender rules – claiming there is deficit spending, there are current account deficits, or twin deficits, capital flight, or whatever the most convenient and prominent excuse of the season.
Instead of the note issue bank failing under its dollar debt from swaps, wiping out the flawed operating framework and new agency with a sound money emerging, after the creation of the IMF, the bad bank is bailed out, confidence in its bad currency is restored by killing private credit and shrinking the economy.
The central bank then lives another day to create monetary problems two years later as private credit recovers.
Will the central bank escape accountability again?
In 2026, however, the central bank cannot escape accountability claiming there is deficit spending or an external current account deficit as the rupee started to fall from early 2025, with the current account in surplus.
This is particularly so because analysts and also the parliament’s Committee on Public Finance (COPF) had already warned of swaps as well as the effect of arbitrary interventions.
In 2026 excess liquidity built up to Rs400 billion from the fx swaps and dollar purchases at depreciating rates. What happened in the past was that when confidence in the rupee was busted by the ‘exchange rate as the first line of defence’ dogma, foreign investors in rupee bonds fled. The macroeconomist then blamed capital flight for the rupee depreciation.
Prime Minister Goh Chok Tong, in a speech at the Monetary Authority of Singapore, which has no political policy rate, once said: “Money has the timidity of a gazelle, the speed of a cheetah, and the memory of an elephant.
“Confidence is a precious commodity,” he pointed out. “Once it is lost it is difficult to regain.”
The Middle East war is manna from heaven for macroeconomists to escape accountability for the effects of arbitrary interventions and the buy-sell swaps and the Rs400 billion of excess liquidity (about twice the level of the Gotabaya era injections), when the external current account was in surplus and people are paying taxes through their nose bringing down deficits (the key scapegoat of the inflationist macro-economist) to near historic lows.
Saving money from macro-economists: Qatar, Dubai, India and Sri Lanka.
It is tragic that an island thousands of miles from the war is hit by depreciation with money under the control of macroeconomists, when in the war zone, money under the control of the ruling family members and protected from macroeconomists and their inflationary rate cuts is sound as a bell.
A victim of the central bank was heard to remark in the presence of this columnist, that it is not only the Sri Lanka rupee that is depreciating, but also the Indian rupee and therefore the central bank should not be blamed for depreciation.
The Reserve Bank of India (RBI) is just as bad as Sri Lanka’s central bank and is also susceptible to various fads that are devised by Western academic inflationists from time to time including targetting inflation without a floating rate.
In fact, RBI was the original inflationist central bank of South Asia which followed Cambridge/Harvard economics of the 1960s and ran into severe currency crises ignoring the advice of BR Shenoy who wrote a ‘note of dissent’ on Mahalanbolis machinations, almost a decade earlier, accurately predicting the outcome. As a result, India ended up with severe trade controls, exchange controls, currency crises, and the Hindu rate of growth. A case in point is Qatar and Dubai.
How Qatar and Dubai escaped the grip of Indian macro-economists, Mahalanobis
Sri Lanka, India, Qatar, and Dubai had the exact same exchange rate when the two South Asian nations got independence over 70 years ago and the Trucial States and Qatar were still British protectorates.
Sri Lanka had a currency board which was originally derived from the Indian rupee and was linked to Sterling after India shifted to the gold standard with the private RBI being started.
Dubai and Qatar were at the time rupeerised (like dollarised) with India rupees. After independence the private RBI set up as a result of the Hilton Young Commission, was nationalised.
In the late 1940s, the Sterling, once the pre-eminent currency of the world, collapsed under Keynesianism several years after the end of World War II taking India and then Ceylon currencies with it.
Be that as it may, when Ceylon got independence (John Exter had briefly considered re-valuing the rupee, records show), the US dollar was 4.76 to the rupee in Sri Lanka, India, Qatar, and Dubai.
In the mid-1960s with full employment policies in full swing, it was clear to British advisors in Dubai and Qatar with knowledge of classical economics that the Indian rupee was going to go down (as this column warned on the rupee due to excess liquidity and rate cuts).
With macroeconomists gaining control of Indian money, a Gulf Rupee was already in existence, which could not be used within India, much to the disappointment of Gulf merchants who had earlier used it for foreign trade.
Qatar and Dubai went on a race against time to set up a currency board to protect themselves from the Indian macroeconomists and the econometricians in the planning commission.
On March 21, 1966, Qatar and Dubai signed the agreement to set up the Qatar-Dubai Currency Board due to a delay in setting up a bigger currency union with Bahrain and Abu Dhabi. The UAE was not yet in existence.
However, before the new notes arrived in Qatar and Dubai the Indian macroeconomists struck on June 06, 1966 and the Indian rupee collapsed to 7.5 to the US dollar.
The Qatar-Dubai currency boards swiftly borrowed 100 million Saudi Riyals and exchanged them for the Gulf Rupee at the old parity rate (4.76 to the US dollar or 106.6 Gulf Rupees to 100 Saudi Riyals).
From September 1966 as the Qatar Dubai Currency Board notes arrived, the Saudi Riyals were exchanged for Qatar-Dubai Riyal with the Emir’s decree suitably amended to reflect change from Gulf Rupees to Saudi Riyals.
When Dubai decided to go with the UAE, the Qatar-Dubai currency board was dissolved and two separate agencies were set up.
Thus, the two nations were saved from macroeconomists and their inflationary policies implemented by rate cuts from ‘monetary policy independence’ which then trigger depreciation and the ensuing social unrest and revolt.
With monetary stability, the people, and therefore the rulers, were also saved.
After the collapse of the Bretton Woods, and full independence from Britain, Qatar flirted with pegging to the SDR but went back to the US dollar peg in 2000. Yemen, however, succumbed.
The two agencies are now called ‘central banks’ but do not have a policy rate. At anytime, with IMF’s ‘monetary policy modernisation’, control could go to macro economists and these oil-rich countries would also down the path of Yemen and Iran.
Since the war against Iran started in the last week of February 2026, the Qatar Riyal is rock solid with no LNG exports at 3.64 to the US dollar. And it has been so, since the year 2000 when the misguided foray into the SDR pegging ended.
The UAE Dirham is also rock solid at 3.67 to the US dollar, with its airport hit by bombs.
On February 27, the day before the Middle East war began, the Indian rupee (the original troubled currency of the 1960s) was 91 rupees to the US dollar. By March 28, it had depreciated to 94.8.
The unsound Sri Lanka rupee, weighed down from money printed from FX swaps, fell from 308 to 311 on March 23, before the large scale offensive was launched by the US and Israel on Iran after falling from 297 through the previous months.
As a result, macroeconomists cannot escape accountability for swaps and excess liquidity, saying money is depreciated due to war.
With the writing on the wall this column had urged the macro-economists to terminate the buy-sell swaps instead of engaging in perfectly useless repo deals giving more profits to banks which were already making enough profits through the central bank swap.
The Threats
The single policy rate is an existential threat to monetary stability, ability to service external debt and to democracy and political stability in Sri Lanka.
Printing money through buy-sell swaps to maintain the single policy rate with excess liquidity (in effect and abundance reserve regime) is an existential threat to monetary stability, debt service, and democracy.
The ‘exchange rate as the first line of defence’ is a masterly device to escape accountability for a flawed operating framework through IMF-backed monetary policy modernisation.
It is also a tool to internalise and amplify external shocks, sabotage fiscal corrections (like energy price hikes) by inflating import and export prices more than necessary and triggering capital flight.
Blocking the Treasury from purchasing dollars in the market (an action which does not create new money) and making Sri Lanka a hostage to central bank reserve collections which involve monetising the BOP and the build up of unsterilised liquidity, is an existential threat to debt service and democracy.
The purchase of dollars by auction at wildly different rates and giving wrong signals to exporters and not through a fixed exchange rate is an existential threat.
Meanwhile, the swap liquidity provides printed money for exporters to hold back and importers to cover early or banks to finance NOPs. By turning newly created inflationary swap money into imports, or preventing current inflows from being turned into debt repayments, an external current account deficit could also be engineered by the macroeconomists.
The Government Acceptance privilege given to an ‘independent’ central bank to increase acceptance of bad rupee notes it produces also pushes the Treasury into a debt trap, just like it forced dependence on central bank reserves to repay debt.
What to do?
The central bank should forthwith unwind its swaps and sell other dollars to the Treasury for cash, reduce excess liquidity and protect the rupee.
This action will reduce the need to sell dollars to the market for imports, by reducing the ability of banks to give investment credits with the new money.
This column has already pointed out that the lack of a falling ceiling on the stock of net credit to the government of the central bank in the IMF programme QPC is a deep flaw. It is a flaw that will take the country to default and President Anura Dissanayake to the cleaners.
If the central bank is unwilling to sell-down the CB bond stock (at an appropriate interest rate by stripping coupons and making deep discount bonds or some other process) and the IMF programme is unable to force it to do so, then the Treasury should be allowed to build its own reserves by dollar purchases and dollar tax revenues.
Monetary reserves cannot be used to repay debt, without altering reserve money. The Treasury should build sinking funds or sovereign wealth funds which are monetary policy neutral to do so.
Any excess cash deposited in banks as a ‘domestic buffer’ which are in turn deposited in the central bank which are used to repay unsubscribed bonds will also lead to exchange rate pressure and lost reserves.
The monopolies and privileges given to macroeconomists should be ended and the Treasury made independent of the central bank to buy dollars or collect tax revenues in currencies it has to settle debt in.
Given the events over 2025 and 2026 and the buildup of excess liquidity to Rs400 billion, it seems that even a 2% inflation target may not be sufficient to restrain the central bank, and an exchange rate target like Qatar and Dubai is the only way to control the agency.
As Sri Lanka is a democracy, it is up to the parliament to prevent macroeconomists from mis-using money to reach political objectives devised by their colleagues in the 1960s through strict laws against the central bank. Sri Lanka is not an Emirate, so money cannot be protected from macro-economists with an Amiri decree as in Qatar.