By the Frontpage Journal Business Desk
Sri Lanka’s financial markets in 2024 saw more than just a turnaround in liquidity, it witnessed a shift in policy posture and institutional credibility. Drawing from the Annual Economic Review 2024 released by the Central Bank of Sri Lanka, the year can be characterized as a phase of strategic re-engagement by the monetary authority to restore confidence, support market stability, and foster an environment conducive to economic recovery.
At the core of this strategy were substantial net foreign exchange purchases by the Central Bank, totaling around Rs. 858 billion. These transactions were not only intended to stabilize the exchange rate and boost official reserves, but also to inject vital rupee liquidity into the domestic money market. In tandem, net foreign currency inflows, particularly through bilateral financing arrangements and swap lines with Licensed Commercial Banks, contributed to a growing liquidity base.
The effects of these interventions were swift and substantial. The domestic liquidity deficit of Rs. 70 billion seen in 2023 transitioned to a surplus of approximately Rs. 120 billion by mid-2024, expanding further to Rs. 168 billion by December. This sharp shift signified a broader recovery in monetary conditions and provided critical breathing room for banks and businesses navigating a fragile recovery path.
Policy facilitation reinforced these developments. Restrictions placed in early 2023 on the Central Bank’s Standing Facilities were first eased in February and fully removed in April. This allowed greater institutional access to overnight funding and helped reduce volatility in short-term interest rates. However, the distribution of liquidity remained uneven.
Large holdings of excess liquidity among foreign banks did not translate into interbank lending, as transaction limits and credit exposures curtailed redistribution to liquidity-starved institutions.
Market functioning improved following a sovereign credit rating upgrade later in the year, which mitigated counterparty concerns and modestly revived the interbank market. Still, the Central Bank continued to play a crucial intermediary role. Through targeted Open Market Operations, it injected liquidity when needed to address mismatches across institutions. These operations were gradually reduced as market conditions normalized, with the overnight reverse repo window being discontinued in December 2024.
In its annual review, the Central Bank emphasized the importance of ensuring that surplus liquidity serves productive purposes without causing inflationary or asset-pricing distortions. The report also highlighted that some liquidity was absorbed via Treasury bond coupon payments, maturities of Central Bank-held Treasury bills, and currency withdrawals, acting as natural stabilizers in the system.
What emerges from the Central Bank’s account is a strategy that went beyond traditional monetary control. The interventions in 2024 were part of a broader confidence-building exercise. In a country recovering from fiscal strain and structural adjustments, these actions signaled predictability, institutional discipline, and a forward-looking policy direction.
As the Central Bank retreats from daily liquidity injections, it leaves behind a market that is stronger but still in need of structural improvements, particularly in interbank liquidity distribution and credit risk management. Going forward, maintaining credibility will be as crucial as managing cash flows.
The experience of 2024 thus offers a lesson in how central banks, through well-timed and transparent action, can rebuild trust in financial systems and create space for sustainable recovery, even in the face of deep macroeconomic challenges.
Source: Central Bank of Sri Lanka, Annual Economic Review 2024
