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Central Bank caught between peg and hard place

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ECONOMYNEXT –Sri Lanka’s central bank has been aggressively injecting liquidity on a longer term in the past weeks reducing liquidity shortages in the banking system, which if overdone could lead to forex shortages and instability again.

The central bank has injected 340 billion rupees through term injections – largely replacing lending window operations from January 09 and overnight injections began on January 17.

While liquidity shortages beyond a certain point have no value, care should be taken to ensure that excess liquidity conditions do not re-emerge.A liquidity shortage emerges in Sri Lanka’s banking system because a pegged regime is operated, despite whatever claims to the contrary.

In past currency crises, almost all the liquidity shortages from dollar sales (losses of foreign reserves) made to defend a peg were filled permanently to maintain an artificially low policy rate.

Currency crises and balance of payments deficits do not come from defending pegs as claimed by post 1935 academics and economic bureaucrats, but from money printed through open market operations to mis-target rates and maintain an artificially low policy rate after intervening.In this currency crisis, the worst created in the history of the central bank of Sri Lanka, large volumes of liquidity were only filled overnight. This is better than filling permanently, as it may prevent banks from giving credit due to asset liability mis-matches.

The liquidity injections allow banks to lend without deposits and trigger forex shortages, expand the external current account deficit – unless they were used to buy assets from fleeing foreign investors and more forex losses.

Classical economists have called such injections ‘fictitious capital’ in a pegged regime.However US academics (led by Mercantilists like John H Williams) and economic bureaucrats who built the Bretton Woods and the International Monetary Fund, thought it was possible to do so as their knowledge of classical theory seemed to have been weak, and instead used statistics to claim that it was possible.

That it was not possible was proved with the collapse of the Bretton Woods. But third world countries – outside of East Asia and GCC – continue to believe that it is possible, with disastrous consequences and never-ending trips to the IMF.A third world country is necessarily pegged. No single anchor regime country will remain poor for long.In past currency crises, foreign reserves losses (losses of NFA) were filled permanent purchases of Treasury securities, so large liquidity shortages running into hundreds of billions of rupees were not seen.

Outside of the net foreign assets losses, in this currency crisis, due to downgrades of credit, foreign banks parked large volumes of cash in the central bank instead of lending in the overnight market in a private sterilization style activity.As a result, a few foreign banks ended up with over 300 billion rupees of excess cash.

This is similar to people withdrawing cash from the banking system and burying them in proverbial coffee tins in their backyard as reportedly happened in the US during the Great Depression.A third reason for expanding liquidity shortages was the roll-over of central bank held Treasury bills (zero coupon bonds) with interest.

As a result, Sri Lanka’s net credit to government went up, without any changes in net foreign assets – since the central bank has run out of reserves – while reserve money or at least notes in circulation fell.

Over the past few weeks, the central bank started injecting liquidity (printing money) on a longer term basis reducing the overnight shortages.In addition, the central bank also stopped banks with excess cash from depositing money in the repo window at 14.50 percent, encouraging them to lend in the overnight market or buy Treasury bills.

This has started to happen and Treasury bill yield are coming down.Any of foreign bank money, or newly injected money that is used to buy Treasury bills will end up in state banks.

The central bank should maintain a liquidity short to absorb any liquidity that foreign banks use up to buy Treasury bills.The central bank was blamed by many for the current high rates.

Though it is true that country’s chronically high rates – and the high rates of all third world soft-pegged countries – are due to monetary instability coming from the central bank’s mis-management of a soft-pegged exchange rate regime, in this currency crises the threat of a domestic debt re-structuring has also contributed.

This column has warned for many years that the central bank cannot inject liquidity to suppress rates when private credit picks up and maintain the peg. Each time it is done, forex shortages emerge and the corrective rates are higher than if the rates were allowed to go up a little naturally to balance domestic credit and savings.

After months of injections, the rupee then collapses and rates go up steeply. This has happened repeatedly and has worsened under flexible inflation targeting. A floating exchange rate regime is needed for any type of inflation targeting (to operate a domestic anchor based monetary regime the external anchor has to be abandoned).In this context caution should be exercised in the current liquidity injections.

Sri Lanka is maintaining a peg at 360 to the US dollar without any reserves at the moment. It is done by a surrender rule where forced sales are made at around that price to the central bank, injecting liquidity and selling the same dollars back to banks.

Depending to the spread, this activity can also lead to liquidity shortages. In fact, the Bank of Thailand many decades ago re-built foreign reserves devastated by Japanese driven money printing during World War II, through such a strategy.

This column has in the past advocated floating the exchange rate and re-pegging, to re-establish the credibility of the peg. Before any float the surrender rule should be removed.

Exporters are still not selling forward, indicating that there is no market credibility for the 360 peg, though the central bank has operated monetary policy consistent with such a regime through liquidity shortages and negative private credit through higher rates.

Until the credibility of the peg is fully restored, some overnight liquidity shortages should to be maintained, especially at state banks, for the following reasons, despite private credit being negative.

a) The Treasury has warned that it may still require printed money. Overnight liquidity short should be large enough to absorb any such injections.

b) The first quarter of any year is where a drought comes and electricity sector losses are financed with credit. This column in early 2021 that rates be hiked and the currency floated before the drought. (Sri Lanka has to hike rates, tourism recovery will not help end forex crisis: Bellwether)

c) The shift of private sterilized money from foreign banks to state bank DST accounts should be absorbed as mentioned before.

This is because any of the new liquidity injections, and the privately sterilized money shifting from foreign banks to state or other banks can create forex shortages if loaned to the Ceylon Petroleum Corporation or Ceylon Electricity Board, to import fuel.

Though private credit is negative and the risks of foreign shortages, re-emerging are reduced, credit given to state energy utilities hit the forex market direct.It is also not clear whether there will be any central bank profit transfers this year. In 2022 NFA was negative, but there are profits from domestic assets which if transferred as printed money can create forex shortages as they are used by the recipients.

That is why this column has advocated in the past that profit transfers be made in US dollars in the first instance and be done with it.Sri Lanka has not yet got the IMF program, therefore confidence is low and any excess liquidity can undermine the very fragile peg.

Though there has been net excess liquidity in the market for a few days, some banks were still short by 132 billion rupees.

The central bank is caught between a peg and hard a place, with a clamour by businesses to bring down rates.In past crises, rates have started to come down from about two to three months after the currency is successfully floated, private credit turns negative and budget deficits begin to narrow .

But there has been no successful float to create credibility of the exchange rate in the market, the IMF deal and the attendant inflows that accompany it are yet to come.

Therefore, despite private credit being negative, due to problems in the CEB in particular and generally the budget, caution has to be exercise in liquidity injections and it will be a prudent strategy to maintain a short overall of at least 50 billion rupees.

After the IMF program comes, or even before that if there is a successful float and re-pegging, the central bank should consider abandoning the floor repo rate.Many East Asian central banks do that and it helps economies recover faster.

The recent blocking of access to the repo window is a similar strategy, but is fraught some risks at the moment because the new liquidity is not coming from an acquisition of foreign assets but from domestic assets.

The central bank could also consider rolling over Treasuries at par through a legal change until they are sold down to re-build reserves after the IMF program comes. This will reduce the government interest bill and eliminate any risks from a single day profit transfer.

Having said that IMF programs are no solution to a trigger-happy pegged bank that injects liquidity through open market operations.

The State Bank of Pakistan is melting now within an IMF program. Sri Lanka had currency problems in both 2011 and 2018 within IMF programs which were temporarily suspended as liquidity injections were made amid high domestic credit which led to missed foreign reserve targets.Liquidity shortages lose their value beyond a certain point, so the recent injections may not be harmful.However care should be taken never to go to back to excess liquidity conditions except through net foreign asset acquisitions.



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Opinion

Can a punishment-free child become a threat to Sri Lankan society?

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Children are the future of every nation, and the values they learn during childhood shape the society they will eventually lead. In Sri Lanka, where family traditions, respect for elders, and social responsibility have long been important cultural values, the way children are raised remains a topic of great interest. In recent years, many parents and educators have moved away from traditional forms of punishment and embraced more child-friendly approaches to discipline. While protecting children from physical and emotional harm is essential, an important question arises: can a child who grows up without any form of punishment or consequences become a threat to Sri Lankan society?

To answer this question, it is necessary to understand the difference between punishment and discipline. Punishment is often associated with penalties imposed for wrongdoing, while discipline refers to teaching children self-control, responsibility, and respect for rules. Modern child psychology generally discourages harsh physical punishment because it can cause fear, anxiety, and resentment. However, completely removing consequences for inappropriate behavior may create a different set of problems.

Sri Lankan society has traditionally emphasized discipline within the family. Parents, grandparents, and teachers have often played active roles in guiding children’s behavior. Respect for elders, obedience, and good manners have been considered important virtues. While some traditional disciplinary methods may no longer be acceptable, the underlying principle of teaching accountability remains relevant.

A child who never faces consequences for wrongdoing may struggle to understand the boundaries that exist in society. For example, if a child is allowed to insult others, damage property, or ignore rules without correction, they may develop the belief that their actions have no consequences. Such attitudes can become problematic when the child enters school, the workplace, or the wider community.

Sri Lankan schools already face challenges related to student discipline. Teachers often report difficulties in managing classrooms where some students refuse to follow instructions or respect school regulations. When children are not taught accountability at home, educational institutions may find it harder to maintain a productive learning environment. This can affect not only the individual student but also classmates whose education is disrupted.

Another concern is the development of entitlement. A child who is never told “no” may come to believe that personal desires should always be fulfilled. In a society where cooperation and mutual respect are essential, such attitudes can lead to conflicts with peers, teachers, employers, and even family members. Sri Lanka’s social fabric depends heavily on community relationships, and individuals who fail to respect others can weaken these bonds.

The influence of social media and modern technology has added another dimension to this issue. Today’s children have access to information and entertainment on an unprecedented scale. Without proper guidance and consequences, some may misuse technology, engage in cyberbullying, spread misinformation, or develop unhealthy habits. Parents who avoid setting limits may unintentionally expose children to risks that affect both personal development and social well-being.

The workplace offers another example of why accountability is important. Sri Lanka’s economic development depends on a workforce that is disciplined, responsible, and capable of working with others. Employers value punctuality, respect, and professionalism. Individuals who grow up without learning responsibility may find it difficult to meet these expectations, affecting both their personal success and the productivity of organizations.

However, it is equally important not to interpret this argument as support for harsh punishment. Research has shown that excessive physical or emotional punishment can have serious negative effects on children. Fear-based parenting may produce obedience in the short term but can damage confidence, trust, and mental health in the long term. Therefore, the solution is not stricter punishment but more effective discipline.

Positive discipline provides a balanced alternative. It involves setting clear rules, explaining expectations, and applying fair consequences when those rules are broken. For instance, if a child neglects schoolwork, they may lose certain privileges until responsibilities are fulfilled. If they damage property, they can be required to help repair or replace it. Such consequences teach accountability while preserving the child’s dignity.

Sri Lankan parents, teachers, and community leaders all have a role to play in nurturing responsible citizens. Families should create environments where children feel loved and supported but also understand that actions have consequences. Schools should encourage character development alongside academic achievement. Religious and community organizations can reinforce values such as honesty, compassion, and respect for others.

A balanced approach is especially important in a rapidly changing society. As Sri Lanka continues to modernize and integrate with the global community, young people must learn not only their rights but also their responsibilities. Freedom without responsibility can lead to selfishness, while discipline without compassion can lead to fear. The challenge is to find the middle ground.

A punishment-free child can become a concern for Sri Lankan society if the absence of punishment also means the absence of discipline and accountability. Children who never learn consequences may struggle to respect rules, authority, and the rights of others. However, harsh punishment is not the answer. The most effective approach combines love, guidance, clear boundaries, and fair consequences. By raising children who understand both freedom and responsibility, Sri Lanka can build a future generation that strengthens society rather than threatens it.

Saumya Aloysius

(An essayist, children’s writer and freelance writer who holds a Master’s Degree in Sociology from the University of Kelaniya)

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Opinion

SriLankan Airbus struck by lightning

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A representational image

On Friday 12 June, 2026, a SriLankan Airlines Airbus 330 was en route from Colombo to Sydney, Australia was about 45 minutes into its flight when a loud bang was heard, accompanied by a blinding flash. In what was assumed to be a lightning strike, the airplane’s left (No. 1) engine was damaged, forcing the aircraft to return to BIA-Katunayake, where it landed safely.

Lightning travels from cloud to cloud or cloud to ground. Because the aircraft is not electrically ‘grounded’, or ‘earthed’, it must have been in the path of the thunder bolt purely by chance. There is also a phenomenon whereby the aircraft may travel through an electrically charged atmosphere (for example a cloud) where an electrical charge could build up and strike, or be emitted, as lightning. In such an instance, pilots hear electrical static in their headsets before the strike. Usually, when lightning strikes an aircraft in flight, the electrical charges remain on the outside, as on a ‘Faraday’s Cage’ apparatus, and the passengers and crew are perfectly safe.

To help the efficient and safe discharge of static electricity from the airplane’s structure, static wicks, or static dischargers, are fitted at the trailing (rearmost) edges of the wings and tail surfaces. When an airplane has landed after a lightning strike, ground engineers count the number of wicks that may have been burnt out to ensure that a minimum (recommended) number is available for a subsequent flight. Sometimes, there is minor damage, like pitting of the paintwork at the points where the charges left the aircraft.

The last instance in the USA of an airplane believed to have been lost due to a lightning strike was on December 8, 1963, when a Pan Am Boeing 707-121, en route from Baltimore, Maryland to Philadelphia, Pennsylvania, suffered a fuel tank explosion, later determined to have been the result of a lightning strike. Since then, aircraft have been rendered immune from lightning damage thanks to extensive research conducted by manufacturers using high-voltage currents.

Interestingly, modern airliners have electronic instrument displays which don’t even flicker when the aircraft is struck by lightning. By a process of connecting all the metallic parts, known as ‘bonding’, the entire fuselage effectively becomes a protective cocoon, so electrical charges caused by lightning will always reside on the outside of the aircraft.

What is unusual in the recent SriLankan Airlines incident is the extent of damage to the left engine. Did it encounter hail or ingest something?

Only a thorough, independent inquiry by aviation safety investigators will reveal the cause.

GUWAN SEEYA

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Opinion

Beyond diagnosis: A strategic design for 7% growth by 2029 (Part I)

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“Vision without execution is hallucination.” – Thomas Edison

Introduction: Stabilisation Is Not Transformation

Sri Lanka has come a long way since the economic collapse of 2022. Inflation has been brought under control. Foreign reserves have improved. Debt restructuring has advanced. Government revenue has increased significantly through taxation reforms. The exchange rate has stabilised, and confidence has gradually returned to financial markets.

These achievements deserve recognition.

However, stabilisation should not be confused with economic transformation. A patient discharged from intensive care is not necessarily healthy. Likewise, an economy that has escaped collapse has not necessarily achieved sustainable prosperity.

The central economic question facing Sri Lanka today is no longer how to avoid another crisis. Rather, it is how to achieve sustained economic growth of at least 7% per annum by 2029.

Unfortunately, much of the current policy debate remains trapped in economic diagnosis. Policymakers, economists, and commentators repeatedly identify familiar problems: (i) low productivity, (ii) weak exports, i(iii) Inadequate innovation, (iv) poor competitiveness, and (v) insufficient investment. While these diagnoses are correct, they are not new.

Sri Lanka now needs economic engineering.

The country requires a clear, measurable, and actionable National Growth Strategy for 2026-2029 that identifies (i) where growth will come from,(ii) what investments are required,(iii) which institutions will lead implementation, and (iv) how success will be measured.

The difference between diagnosis and engineering is the difference between describing a problem and solving it.

The Missing National Growth Target

One of the most striking weaknesses in Sri Lanka’s economic discourse is the absence of a publicly articulated growth target supported by a detailed implementation framework.

Successful economies establish measurable objectives.

Sri Lanka should adopt the following growth trajectory:

2026 – 4%

2027 – 5%

2028 – 6%

2029 – 7%

Such targets would provide direction to investors, public institutions, universities, exporters, and development partners. Without a destination, even the best policies risk becoming disconnected initiatives.

Today, many policy interventions appear fragmented—valuable in isolation but lacking integration into a broader national growth framework.

Growth Will Not Come From Consumption

For decades Sri Lanka relied heavily on consumption, imports, remittances, tourism, and external borrowing.

That model has reached its limits.

No country has achieved sustained prosperity through consumption-led growth alone.

The countries that transformed themselves—Singapore, South Korea, Ireland, Vietnam, and China—generated growth through productive investment, exports, industrialisation, and integration into global markets.

Sri Lanka’s future growth must therefore be driven by investment and exports rather than domestic consumption.

The challenge is not increasing spending but increasing productive capacity.

Export-Led Growth: The First Pillar of Transformation

Every successful Asian growth story has one characteristic in common: exports.

Exports generate foreign exchange, create jobs, attract investment, encourage innovation, and improve productivity.

Sri Lanka should establish an ambitious target of doubling export earnings within the next decade.

This requires moving beyond traditional exports and expanding into:

High-value agriculture

Food processing

Information technology services

Logistics services

Advanced manufacturing

Professional services

Export growth must become a national mission comparable to post-war reconstruction efforts seen elsewhere in Asia.

Without a major expansion of exports, sustained 7% growth will remain elusive.

Manufacturing: The Forgotten Growth Engine

Manufacturing remains the single most important source of rapid economic transformation worldwide. Vietnam provides perhaps the best recent example.

Through (i) industrial zones, (ii) trade agreements, (iii) infrastructure development, and (iv) targeted investment attraction, Vietnam became deeply integrated into Asian production networks.

Sri Lanka possesses strategic advantages:

A prime Indian Ocean location

Strong port infrastructure

Educated labour force

Proximity to India

The country should establish specialised manufacturing clusters focusing on:

Electronics assembly

Medical devices

Processed food products

Boat building

Rubber-based products

Engineering components

Rather than attempting to compete with every country, Sri Lanka should specialise in selected niches where competitive advantages can be developed.

RCEP: The Strategic Door to Asia

Sri Lanka’s future lies increasingly in Asia.

The Regional Comprehensive Economic Partnership (RCEP) represents the largest trading bloc in the world and includes many of the fastest-growing economies.

Membership or closer integration with RCEP supply chains could provide Sri Lankan exporters with access to markets, investment, technology, and production networks that are currently beyond reach.

Unfortunately, discussion on RCEP remains limited compared with its strategic significance.

A dedicated national roadmap for RCEP engagement should become a top economic priority.

The question is not whether Sri Lanka can afford to integrate more deeply into Asia.

The question is whether Sri Lanka can afford not to.

Knowledge Economy: Turning Universities Into Growth Institutions

Sri Lanka’s universities produce thousands of graduates annually, yet their contribution to commercial innovation remains limited.

Globally, universities have become engines of economic development.

Research institutions should not merely produce graduates; they should produce patents, technologies, startups, and commercial solutions.

A national innovation framework should:

Link universities with industry

Encourage commercialisation of research

Support technology transfer

Expand startup financing

Reward innovation and entrepreneurship

Knowledge must become an economic asset rather than an academic exercise.

Dairy, Agriculture, And Import Substitution

Export growth alone is insufficient.

Sri Lanka must also reduce unnecessary import dependence.

The dairy sector offers a compelling example.

For decades, billions of rupees have left the country through dairy imports despite favourable climatic conditions and substantial agricultural potential.

A comprehensive dairy development strategy should focus on:

Improved genetics

Feed production

Commercial farming

Processing investment

Farmer productivity

The objective should be import substitution combined with rural income growth.

The same principle can be applied selectively to other sectors where domestic production is economically viable.

Creating A National Investment Targeting Agency

Sri Lanka does not need another bureaucracy.

It needs a professional institution dedicated exclusively to investment targeting.

Instead of passively waiting for investors, this agency would actively identify and attract strategic investments aligned with national priorities.

Its mandate would include:

Identifying priority sectors

Marketing opportunities globally

Coordinating approvals

Monitoring outcomes

Facilitating technology transfer

Singapore’s Economic Development Board and Ireland’s Industrial Development Agency demonstrate how targeted investment institutions can transform national economies.

Sri Lanka requires a similar mechanism adapted to local realities.

From Economic Diagnosis To Economic Engineering

The next stage of Sri Lanka’s recovery requires a fundamental shift in thinking.

The policy debate must move beyond identifying problems. The country already knows its problems.The challenge is implementation.Every policy proposal should be evaluated against a simple question:

Will this contribute to achieving 7% growth by 2029?

If the answer is no, resources should be redirected.

Economic engineering requires focus, prioritisation, accountability, and measurable outcomes. The era of fragmented initiatives must give way to a coherent national growth strategy.

Summary

Sri Lanka has achieved significant macroeconomic stabilisation, but stabilisation is only the first step toward sustainable prosperity.

To move from recovery to transformation, Sri Lanka should adopt a National Growth Strategy for 2026-2029 built around five pillars:

Export-led growth

Investment-led growth

Manufacturing expansion

Knowledge-economy development

Regional integration through RCEP and Asian supply chains

Supporting sectors such as dairy, tourism, logistics, and information technology should be strategically developed within this framework.

Most importantly, investment must be targeted rather than scattered, supported by specialised institutions and measurable performance indicators.

Conclusion

History demonstrates that no nation has become prosperous by accident. Economic success is rarely the product of isolated policies or short-term political initiatives. It is the outcome of a deliberate strategy pursued consistently over many years.

Sri Lanka stands at a crossroads.

One path leads to modest growth, periodic crises, recurring debt challenges, and continued vulnerability. The other leads to transformation through investment, exports, innovation, manufacturing, and regional integration.

The choice is ultimately strategic.

The time has come for Sri Lanka to move from economic diagnosis to economic engineering.

The future will not be determined by how successfully the country stabilised after the crisis. It will be determined by how effectively it builds the foundations for sustained growth thereafter. If Sri Lanka can articulate and execute a coherent investment-led growth strategy today, achieving 7% growth by 2029 need not be an aspiration.

It can become a national objective—and a national achievement, economic Engineering

The writer, among many, served as the Special Advisor to the Office of the President of Namibia from 2006 to 2012 and was a Senior Consultant with the UNDP for 20 years. He was a Senior Economist with the Central Bank of Sri Lanka (1972-1993). He can be reached via asoka.seneviratne@gmail.com

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