A monetary policy shift is in the offing

Over the next six months of this year, we will see significant changes in monetary policy and the use of macroprudential policy tools to bring private credit growth back, at least to a moderate level of around 13% or so. The objective is to stabilise and prevent significant volatility in the foreign exchange rate.

A stable exchange rate is crucial to a country’s economic growth. This is true for a country that plans to increase Foreign Direct Investment to balance the Balance of Payments when a persistent deficit-prone national current account exists.    

Sri Lanka’s current account has come under renewed pressure in 2026, after showing improvement during much of 2024 and 2025.

I strongly support a stable exchange rate rather than an unpredictable floating exchange rate. The reason is to ensure robust, resilient economic growth. No economy can basically grow without the continuous increase of what is known as the “total sellable output”, which strictly is not GDP. Business sector investments significantly contribute to the total sellable output in a country. These investments are crucial for economic growth as they drive capital formation, enhance productivity, foster innovation and exports. Therefore, investor confidence is important to ensuring economic growth.

Investor confidence does not arise from political rhetoric. There is one important single criterion that any investor – foreign or local – looks at before making any investment decisions. That criterion is the stability of the foreign exchange rate. They generally hate the floating rate of foreign exchange, but at the same time, they do not trust a strongly managed foreign exchange rate mechanism artificially. 

In the past few weeks, investors lost confidence in the monetary authority’s ability to ensure a stable managed exchange rate mechanism. If the monetary authorities did not take proactive action to avoid the next impending exchange rate volatility after the removal of the 50% surcharge imposed on vehicle import duty in August, as promised to the IMF, the lack of confidence in the monetary authorities' ability to ensure a stable foreign exchange rate mechanism would be badly embedded into the mindset of investors.

Therefore, the Central Bank of Sri Lanka (CBSL) should clearly explain its strategy for ensuring exchange rate stability because the exchange rate is the most important variable in Sri Lanka’s economy, as macroeconomic fiscal variables show significant improvements. Without a well-communicated strategy to stabilise the foreign exchange rate, uncertainty can increase and undermine business confidence.

Given Sri Lanka’s experience with repeated balance of payments crises, CBSL could strengthen confidence by explaining a medium-term exchange rate strategy or framework, as certain indicators such as private credit growth, import demand, reserve adequacy and capital inflows are monitored by the CBSL. Obviously, this framework might explain the policy tools such as interest rates, macroprudential measures, and liquidity management tools that will be used by the CBSL, although foreign exchange interventions are very unlikely. Also, this framework might further explain how the exchange rate policy or strategy supports both price stability and external sector sustainability. Ultimately, the same framework would explain how far the CBSL could deviate from the macroeconomic framework set by the IMF, under the improved or deteriorated conditions of the economy.    

I do not suggest that CBSL should target a fixed exchange rate. Rather, a transparent strategy explained through a well-focused framework helps markets understand how the central bank will respond to evolving economic conditions, making exchange rate movements more orderly and reducing the likelihood of destabilising speculations. The most important objective of this task is to increase investor confidence to ensure a continuously increasing total sellable output, ensuring optimum economic growth.