Sri Lanka is once again confronting mounting economic uncertainty as the Sri Lankan Rupee continues to weaken against the United States Dollar, renewing concerns over inflation, debt sustainability, and the rising cost of living.
Following a period of relative exchange rate stability after the 2022 economic crisis, the rupee has recently slipped beyond the Rs. 325 mark against the dollar, reigniting debate over the resilience of the country’s fragile recovery.
Economists warn that continued depreciation could trigger a cascading impact on inflation, domestic production costs, export competitiveness, and investor confidence. However, Government officials maintain that the present volatility remains manageable and reflects policy-driven reserve accumulation and external market conditions rather than a systemic domestic breakdown.
Treasury perspective on debt and inflation
Treasury Deputy Secretary Ananda Kithsiri Seneviratne, outlining the Government’s position on the currency movement, argued that the increase in debt measured in rupee terms should not be interpreted as an immediate fiscal threat.
“While the debt stock is increasing in rupee terms, our current foreign debt stands at approximately $ 38 billion. Therefore, a Rs. 1 depreciation increases the debt stock by roughly Rs. 40 billion.
“However, when measured against our Rs. 32 trillion Gross Domestic Product (GDP), this increase is relatively insignificant. It does not create a major immediate impact on debt servicing and repayment. The primary long-term consequence of currency depreciation is the pressure it places on the cost of living rather than the national debt itself,” Seneviratne stated.
Responding to speculation that the Government had resorted to monetary expansion to finance expenditure, he firmly denied allegations of excessive money printing.
“Under the Central Bank of Sri Lanka (CBSL) Act, printing money is strictly prohibited. The current inflationary pressure is driven primarily by exchange rate movements. The depreciation is largely the result of the Central Bank purchasing dollars from the market to strengthen national reserves.
“In addition, the import ceiling for the Ceylon Petroleum Corporation (CPC) was recently increased from $ 100 million to over $ 400 million. That sharp increase in dollar demand by a single State institution has significantly influenced the exchange rate,” he explained.
Funding relief without expanding the deficit
Amid growing public concern over living costs, the Treasury has introduced a Rs. 100 billion relief package aimed at cushioning vulnerable groups while maintaining fiscal discipline under the International Monetary Fund (IMF) programme.
“We are announcing a comprehensive Rs. 100 billion relief package. This funding is sourced entirely through the reallocation of existing provisions. Savings generated from delayed capital expenditure, reduced recurrent expenditure, and funds originally allocated for cyclone-related contingencies are being redirected towards this effort. The budget deficit is not increasing, and there is no shortfall in Government revenue,” Seneviratne noted.
He added that the current exchange rate trajectory remained broadly within the Government’s original economic forecasts.
“At the beginning of the year, we estimated that the dollar would average around Rs. 330, and the current range of Rs. 330–335 remains within our projections. The recurrent side of the budget is only marginally affected because obligations such as pensions are fixed. Through the relief package, we are allocating Rs. 15 billion upfront for electricity subsidies to protect consumers using less than 180 units. However, the Government cannot provide universal relief. We are operating strictly within the framework of the IMF programme, and any relief measures must be implemented in consultation with them. The maximum allocation permitted is Rs. 100 billion,” he said.
Structural vulnerabilities and BOP
Despite official assurances, economists argue that the depreciating rupee exposes unresolved structural weaknesses within the Sri Lankan economy, particularly its heavy dependence on imports.
University of Peradeniya (UOP) Department of Economics and Statistics Professor Ananda Jayawickreme warned that the weakening currency could significantly worsen the country’s Balance of Payments (BOP) position.
“The sliding rupee is severely affecting the BOP because Sri Lanka consistently runs a large trade deficit. Our import structure is difficult to alter because essential imports such as petroleum products, industrial raw materials, and fertiliser are not highly price-sensitive. As a result, a weaker rupee immediately inflates the import bill. Domestic prices rise accordingly, including the prices of locally available substitutes,” Prof. Jayawickreme stated.
While agreeing that excessive money printing was not driving current inflation, he argued that rising import costs were undermining the competitiveness of Sri Lankan exports.
“The current monetary expansion is limited and largely intended to facilitate transactions. It is not comparable to the excessive money printing witnessed during the previous administration. The larger issue is that imported raw materials are becoming increasingly expensive, driving up production costs across the economy.
“Consequently, the final prices of export goods such as garments and tea rise, reducing our competitiveness in international markets. We are spending more on imports while simultaneously risking a decline in export earnings. This cycle further aggravates the dollar shortage and contributes to continued currency depreciation,” he observed.
Pressure on exports and domestic production
UOP Department of Economics and Statistics Head Prof. Ariyarathna Herath warned that prolonged depreciation could undermine the broader economic recovery, particularly for Small and Medium-sized Enterprises (SMEs).
“The continuous depreciation negatively affects debt repayment capacity and complicates the debt restructuring process. Since the exchange rate is one of the most critical macroeconomic variables, its decline affects aggregate demand and ultimately reduces national income. SMEs are likely to be among the hardest hit. Businesses already consider the current tax regime, including high corporate taxation, to be burdensome. Rising prices for imported raw materials are making production costs increasingly unsustainable,” Prof. Herath said.
He added that the theoretical benefits of a weaker currency for exporters were largely offset by Sri Lanka’s dependence on imported industrial inputs.
“In theory, depreciation should benefit exporters. However, because Sri Lanka imports a substantial share of the raw materials required for domestic production, those higher import costs are transferred directly into the final product. When combined with high corporate taxes, income taxes, and value-added taxes, Sri Lankan export products become more expensive than competing goods in the region. Although exporters gain marginally from the exchange rate, they continue to face serious challenges in maintaining international competitiveness,” he explained.
Concerns over taxation and informal economy
Both economists also raised concerns about the broader tax environment, particularly the introduction of new taxes on digital services during a period of weakening consumer purchasing power.
Prof. Herath criticised the imposition of a 20.5% Value-Added Tax (VAT) on digital transactions, arguing that it could discourage formal economic participation and drive consumers towards unregulated alternatives.
“Introducing a 20.5% VAT on digital transactions is counterproductive. If the national objective is to encourage digitalisation and secure financial transactions, these services should be supported rather than heavily taxed.
“Excessive taxation and restrictions inevitably encourage the expansion of black markets. In many rural areas, consumers are already shifting towards illicitly manufactured liquor because licensed products have become unaffordable. Persistently increasing taxes across sectors will ultimately expand the informal economy and reduce Government revenue,” he remarked.
Prof. Herath further warned that the combined effect of high taxes and currency depreciation was suppressing domestic demand.
“Consumption remains a major component of aggregate demand. High taxes have significantly reduced disposable income and purchasing power. At the same time, the depreciating rupee is driving up the cost of imported goods. As prices continue to rise, many products are becoming increasingly unaffordable for ordinary citizens. Given the current global economic climate and ongoing regional conflicts, economic growth is likely to remain weak this year and could continue slowing over the next two years,” he noted.
Policy recommendations and outlook
To stabilise the currency and preserve foreign reserves, economists called for immediate policy intervention and tighter management of non-essential imports.
Prof. Jayawickreme argued that restrictions on vehicle imports should be considered until macroeconomic conditions stabilised.
“Immediate steps must be taken to reduce unnecessary dollar outflows. Vehicle imports, in particular, should be restricted until the economy stabilises. When the rupee begins to depreciate, it creates negative market expectations. Investors and migrant workers may delay remitting foreign currency because they anticipate further depreciation and hope to obtain more rupees later. That expectation itself accelerates the downward pressure on the currency,” he said.
Prof. Herath also emphasised the need for coordinated intervention by the Ministry of Finance and the CBSL.
“The Ministry of Finance and the CBSL must work together to release dollars into the market from excess reserves where necessary. Without intervention, declining remittances caused by global geopolitical instability and weaker export earnings resulting from rising production costs will slow the inflow of foreign exchange. Unless the CBSL intervenes strategically to stabilise the market, the depreciation will continue,” he concluded.