Sri Lanka's central bank successfully purchased $113 million from the forex markets in December 2023, culminating in a total of $1.895 billion for the year. This achievement was supported by a deflationary policy stance, initiated with rate increases from April 2022 to address a balance of payments crisis triggered by prior rate cuts and aggressive liquidity injections. Such actions historically led to forex shortages, loss of confidence, and necessitated steep rate hikes and economic contraction to restore currency stability.
Monetary stability was regained around August/September 2023, allowing the central bank to buy dollars and absorb the liquidity these purchases generated. The process was facilitated by imposing counterparty limits on banks' access to central bank funds, addressing the long-standing issue of banks' reliance on central bank windows due to habitual easy money practices. Lifting these counterparty limits has been seen as a move to end the severe currency crisis, marking a significant shift from the destabilizing monetary practices of the past.
With the establishment of monetary stability, Sri Lanka's economy began to recover in 2023, leading to falling interest rates and the appreciation of the exchange rate. This recovery aligns with the typical pattern observed in the first year of an IMF program, where the collection of reserves puts upward pressure on the exchange rate. However, there's caution against reverting to inflationary policies as the economy recovers, a practice that has previously triggered forex shortages, undermining the stability achieved. Critics highlight the IMF's role in promoting such practices, contrasting with classical economic principles that advocate for monetary stability.