Imagine you are cooking a delicious dhal curry. You taste it and realise it is lacking salt; just a little adjustment is needed to make it perfect. You add a pinch, taste again, and it’s just right.
But what happens if you accidentally add too much? Suddenly, it becomes overpowering and you are unable to enjoy the dish. So you try a few tricks, perhaps adding a splash of coconut milk to reduce the saltiness, a squeeze of lime to brighten the flavour, or even a piece of bread to soak up the excess.
Now, picture that dhal curry as Sri Lanka’s economy, with salt as inflation and deflation, and the Central Bank of Sri Lanka (CBSL) as the cook. Just like a cook, the CBSL constantly tastes and tweaks, using different tools to keep the economy balanced and inflation palatable. It is a delicate act of adjustment, ensuring that each ingredient – interest rates, money supply, and regulations – works together to keep the entire dish, or economy, just right for everyone to enjoy.
This analogy becomes particularly relevant as the current Government, once a strong critic of the previous administration’s money-printing policies, now faces similar scrutiny.
It was recently reported that the CBSL had injected Rs. 100 billion into the economy through Open Market Operations (OMOs) on 25 October. This move, often referred to as ‘printing money,’ fuelled speculation and criticism. However, both the Government and the CBSL were quick to deny these claims, insisting that no such money printing had occurred.
Reserve money trend since election week
Based on the weekly economic indicators of the CBSL, between 20 September and 25 October, there has, in fact, been a drop in the reserve money. The report for 20 September shows the reserve money at Rs. 1,547,274.06 million, whereas the 25 October report shows it at Rs. 1,499,941.29 million. The difference indicates a reduction in reserve money over this period.
However, analysed on a weekly basis, from 20 September to 25 October, the reserve money in Sri Lanka showed noticeable fluctuations. Starting with 1,547,274.06 on 20 September, the reserve money decreased to Rs. 1,516.03 billion by 27 September.
The following week, ending 4 October, saw Rs. 1,520.30 billion in reserve money. During the week ending 11 October, reserve money dropped to Rs. 1,499.80 billion, a decline of Rs. 20.5 billion.
However, by 18 October, the reserve money rebounded slightly to Rs. 1,511.98 billion, an increase of Rs. 12.18 billion. The period concluded on 25 October with reserve money at Rs. 1,499.94 billion, marking a small decrease of Rs. 12.04 billion from the previous week.
Is an increase in reserve money always about money printing?
An increase in reserve money is not always about money printing. There are many reasons why reserve money might fluctuate that do not involve the direct creation of new money by the central bank.
Sometimes, central banks conduct open market operations to adjust the level of money in the banking system without necessarily printing new money. Another reason for an increase in reserve money could be the central bank buying foreign currency to keep the exchange rate stable. When this happens, domestic currency is injected into the economy, which increases reserve money.
Sometimes banks choose to hold more reserves at the central bank due to economic uncertainty or changes in regulations that require them to keep more reserves. This can also increase reserve money.
CBSL explanation to money printing speculation
Vehemently denying money printing allegations, the CBSL, issuing a statement, stated that these claims were inaccurate and baseless.
“The liquidity (money) injected through OMOs is a routine central banking function aimed at managing adequate liquidity in the banking system for the purpose of stabilising the short-term interest rates in the economy and ensuring price stability, and hence it should not be grossly misinterpreted as ‘money printing,’” the bank stated.
According to the CBSL, during 2024, the bank has conducted frequent liquidity injections due to persistent liquidity asymmetries, despite the prevailing surplus in the banking system.
It added that certain commercial banks had faced severe liquidity shortfalls due to stricter exposure limits for interbank transactions following the sovereign credit rating downgrade. Money market lending by the foreign banks operating in Sri Lanka has remained limited, despite their significant liquidity surplus, due to the strict exposure limits.
Hence, the CBSL’s liquidity injections have addressed these shortfalls, ensuring that short-term interest rates, especially the call money rates, remain stable. Without such interventions by the CBSL, short-term interest rates could have increased sharply, disrupting the broader economy and affecting the CBSL’s ability to meet its inflation target, the statement noted.
Govt. reacts to money printing claims
Cabinet Spokesperson Minister Vijitha Herath asserted that the new Government had neither printed currency notes nor taken loans from any foreign institution.
Herath explained: “Generally, the CBSL follows a routine process of issuing new Treasury bills and bonds proportionally as previous ones reach maturity. This is a standard daily operation.”
“As for currency printing, no new notes have been issued, and it simply cannot be done. While we too would like to see a note with the new President’s signature, nothing like that has been released. This is entirely fake news,” he asserted.
‘A complete misunderstanding’
Speaking to The Sunday Morning, former Deputy Governor of the CBSL Dr. W.A. Wijewardena described this as a “complete misunderstanding”.
He stated that money did need to be printed and supplied to the economy, especially as it grows. The CBSL must provide the necessary medium of exchange in adequate amounts to support economic growth, so new money has to be issued.
For example, if the economy has grown by 4% this year, then more money needs to be supplied to allow for these additional transactions. Dr. Wijewardena explained that money printing was not something new; rather, it was an ongoing requirement and not just in recent times.
“We have data related to money printing until the end of August, covering the period of former President Ranil Wickremesinghe’s Government. During the one-year period ending in August, about Rs. 1.2 trillion in new money was supplied to the economy, which is a significant amount.
“Imagine if coconuts were the only commodity in the country. With 100 coconuts and 100 units of money, the exchange rate would be one coconut per unit of money. If production rose to 200 coconuts but the money supply stayed at 100 units, coconut prices would fall, causing deflation. To keep prices stable, the Central Bank would need to increase the money supply to 200 units to match the new production level,” he explained.
Accordingly, the role of the Central Bank in this instance is to prevent both inflation and deflation. It has to ensure the money supply grows in line with economic growth.
Dr. Wijewardena added that Sri Lanka was currently experiencing deflation, with the price index dropping by 0.8% as of October. To counteract this, the CBSL must print more money.
According to him, the new CBSL Act requires the CBSL to agree with the Government on an inflation target each year, and in 2023, it had set a target to maintain inflation at 5% in 2024, with a permissible range of 3-7%. Since inflation is currently at a negative 0.8%, the CBSL is performing relative to this target and therefore needs to increase the money supply.
‘Not a new practice’
Meanwhile, Frontier Research Head of Macroeconomic Advisory Chayu Damsinghe stated that currently, under the new CBSL Act, the “monetisation of the deficit” was explicitly prohibited, unlike under previous monetary laws. This refers to the practice where the CBSL purchases Government securities issued by the Treasury in the primary market.
“Put simply, if the Government or Treasury needs funds for expenditure, they cannot issue debt that the CBSL then buys by printing new money. The CBSL cannot provide money directly to the Government for its own spending,” he said.
Damsinghe explained that the CBSL Act banned any situation where the bank creates money out of nothing and freely hands it to the Government to fund expenditure.
“Although there are indirect ways in which the CBSL might try to work with other Government agencies, the new act strictly prohibits direct funding of Government spending. Additionally, the Supreme Court’s interpretation of the act reinforced that money printing to enable unrestricted Government spending is not permitted.
“However, what the CBSL can and continues to do is manage liquidity in the secondary market through operations such as OMOs. This is not a new practice but an ongoing one. Currently, the CBSL injects liquidity into financial markets as needed, but in the past, it has also removed liquidity when the market had excess. Right now, its goal is to maintain a balanced level of liquidity,” Damsinghe pointed out.
Although political motivations can often disrupt rational economic solutions, money printing remains a necessary tool for the CBSL. It helps maintain inflation at an optimal level and ensures balanced liquidity in the economy, but it must of course be done properly, driven by economic necessities instead of mismanaged economic policies.
Caption:
Reserve money in Sri Lanka – 20 Sept.-25 Oct.
