By Shihar Aneez
COLOMBO – The recent sharp decline of the Sri Lankan Rupee (LKR) over the past month has reignited anxieties reminiscent of the 2022 financial collapse.
The rupee has fallen more than 5% so far this year to a level seen in 2022 after being stable for more than three years.
While the Central Bank Governor Nandalal Weerasinghe has attributed this volatility to global trends, likely strengthening of the US Dollar and shifting international commodity prices, the domestic implications are profound.
For a nation still in the fragile stages of an International Monetary Fund (IMF)-backed recovery, currency depreciation is not merely a technical adjustment; it is a direct threat to the standard of living for every citizen not earning in foreign exchange.
The ripple effects of the depreciation could be detrimental for Sri Lanka’s recovering economy under an IMF deal. Here are a few effects that could adversely impact the island nation:
Inflation
Sri Lanka remains heavily dependent on imports for essential goods, including fuel, medicine, and food. When the rupee loses value, the cost of bringing these goods into the country rises instantly.
Cost-push inflation is the most direct consequence. As the landing cost of fuel increases, transport and production costs across all sectors rise, leading to a second wave of price hikes.
In 2022, hyperinflation peaked near 70% following the sudden float of the rupee. While the current depreciation is less drastic, it threatens to reverse the disinflationary trend achieved in early 2025.
Already, the inflation has spiked to 5.4% in April from 2.2% in the previous month, mainly due to a sharp fuel price increase and its spillover effects. The recent rupee depreciation has yet to be absorbed into prices.
Cost of Living
For the average household, depreciation translates to a hidden tax.
As prices for electricity, gas, and groceries climb, the portion of income available for education, healthcare, and savings shrinks.
The 2022 crisis proved that the middle class is the most vulnerable to sudden depreciation, as their fixed salaries fail to keep pace with the rapidly rising cost of a basic consumption basket.
In 2022, the sudden and uncontrolled floating of the Sri Lankan Rupee acted as a primary catalyst for the nation’s deepest economic collapse, causing the currency to lose over 60% of its value within months.
This sharp depreciation triggered a cost-push inflationary spiral that saw headline inflation peak at an unprecedented 70%, while food inflation soared near 95%.
For the average Sri Lankan, this meant the price of essential imports such as fuel, cooking gas, and medicine doubled or tripled almost overnight, effectively wiping out the purchasing power of fixed-income earners and pushing millions into food insecurity.
Today, while the current depreciation is more gradual and attributed by the Central Bank to global trends rather than domestic depletion, the impact remains a significant threat to household stability.
Unlike the 2022 shock, which was characterized by absolute shortages and queues, this gradual slide serves as a silent tax, steadily eroding the marginal gains made during the recent disinflationary period.
As transport costs and electricity tariffs rise in tandem with the weakening rupee, hardworking families again face the prospect of a nutritional trade-off, where the increasing cost of imported inputs for production and logistics forces a reduction in the quality and quantity of daily consumption.
The Central Bank typically responds to depreciation and rising inflation by tightening monetary policy to prevent the currency from spiralling and to anchor inflation expectations.
Higher interest rates make borrowing expensive for households and businesses, effectively slowing down the circulation of money in the economy.
In 2022, the catastrophic and sudden collapse of the Sri Lankan rupee forced the Central Bank to adopt an ultra-aggressive monetary stance to prevent a total economic freefall.
As the rupee’s value plummeted, the ensuing hyperinflation necessitated a massive shock to the financial system.
To anchor inflation expectations and halt the rapid depletion of foreign reserves, the Central Bank implemented a historic interest rate hike, nearly doubling the Standing Deposit Facility Rate (SDFR) and the Standing Lending Facility Rate (SLFR) to 14.50% and 15.50%, respectively, in a single day.
This very tight monetary policy was a defensive manoeuvre intended to mop up excess liquidity, discourage speculative hoarding of foreign currency, and provide a much-needed incentive for domestic savings.
In contrast, the latest gradual depreciation in 2026 presents a more nuanced challenge for policy rates.
Unlike the emergency hikes of 2022, the current slide is being monitored within the framework of an inflation targeting regime.
The Central Bank is likely to avoid sudden, massive rate hikes, as the depreciation is incremental and partly driven by global dollar strength.
However, if the weakening rupee begins to put sustained upward pressure on imported inflation, particularly through rising fuel and energy costs, the Central Bank may be forced to pause its current easing cycle as soon as the next monetary policy meeting scheduled for May 25.
Instead of further rate cuts to stimulate growth, the Central Bank will likely maintain higher-for-longer policy rates to protect the rupee’s stability and ensure that the country remains compliant with the fiscal and monetary targets set under the ongoing IMF recovery program.
Economic Growth
While a weaker currency can theoretically help exports, in the short term, it often stifles growth in a developing economy.
Industries that rely on imported raw materials, like construction and manufacturing, face higher capital requirements. Rapid fluctuations in the rupee also discourage both domestic and foreign direct investment (FDI), as investors cannot accurately predict their returns in real terms.
In 2022, the sudden collapse of the rupee acted as a primary driver of a severe economic contraction, causing the national GDP to shrink by over 7%.
The sharp depreciation triggered a shock across all sectors; as the cost of imported raw materials and fuel spiked, industrial production ground to a halt and the construction sector collapsed under the weight of surging input prices.
The record rate hike by the Central Bank to combat the resulting hyperinflation and stabilize the currency effectively froze the economy by making credit unaffordable for businesses and households, further stifling investment and consumption.
The combination of diminished purchasing power and the high cost of capital created a deep recessionary cycle that wiped out years of developmental gains.
In contrast, the latest gradual depreciation in 2026 poses a different set of risks to economic growth.
While it is not currently causing the systemic paralysis seen in 2022, the incremental weakening of the rupee acts as a persistent drag on the recovery process.
This measured slide increases the cost of energy and logistics, which could trim the projected growth margins for the manufacturing and SME sectors.
If the depreciation forces the Central Bank to raise interest rates to protect the rupee, it may reverse the full-scale rebound in private sector credit.
Consequently, while the economy is no longer in a freefall, this gradual loss of currency value threatens to turn a potential high-growth recovery into a period of sluggish, low-momentum expansion, making it harder for the country to reach its pre-crisis output levels.
Job Creation
Job creation is a byproduct of economic stability and corporate expansion as companies grapple with higher energy costs and debt servicing due to rising interest rates.
During the height of the crisis, many SMEs closed down permanently. A renewed period of instability risks another wave of layoffs, particularly in the construction and retail sectors.
In 2022, the uncontrolled depreciation acted as a massive shock to the labour market, leading to widespread job losses and a near-complete freeze on new job creation.
The astronomical rise in the cost of imported raw materials and fuel forced many industrial units, particularly in the SME, construction, and manufacturing sectors, to scale down operations or shut down entirely.
This contraction was exacerbated by the Central Bank’s necessary but painful decision to implement an ultra-tight monetary policy; with interest rates doubling, businesses lost access to affordable working capital, making it impossible to maintain payrolls or invest in expansion.
For the first time in decades, Sri Lanka saw a significant reversal in employment gains, as the shock of the depreciation outpaced the ability of firms to adjust their cost structures.
In the current environment of 2026, the latest gradual depreciation presents a more subtle but persistent challenge to job creation.
Unlike the sudden paralysis of 2022, this gradual weakening of the rupee acts as a slow erosion of corporate profit margins due to rising energy and logistics costs.
While it is not currently triggering mass layoffs, it creates an atmosphere of caution among employers.
If the depreciation persists, companies may opt for hiring freezes to offset higher operational overheads, prioritizing survival over expansion.
Furthermore, if the Central Bank is forced to keep interest rates elevated to protect the rupee, the high cost of borrowing will likely discourage the capital investments needed to create new, high-quality jobs.
Consequently, while the labour market is not in a freefall, this gradual loss of currency value threatens to turn a period of potential job growth into one of stagnation, making it difficult for the economy to generate the volume of opportunities required for the new generation of the workforce.
Exports
Theoretically, depreciation makes Sri Lankan exports such as tea, apparel, and rubber cheaper and more competitive globally.
In 2022, the sharp depreciation presented a paradoxical challenge for the export sector, which is traditionally expected to benefit from a weaker currency.
While a devalued rupee theoretically makes exports more price-competitive globally, the sheer velocity of the 2022 collapse shattered the cost structures of major exporters in the apparel, tea, and rubber industries.
Because these sectors rely heavily on imported inputs such as fabric, fuel, and fertilizers, the import-led inflation triggered by the depreciation rapidly erased any competitive pricing advantages.
Furthermore, the accompanying domestic economic instability, fuel shortages, and the Central Bank’s spike in interest rates to stabilize the currency meant that exporters faced a massive increase in the cost of working capital and logistics.
This forced many firms to focus on survival rather than expansion, preventing the country from fully capitalizing on the weaker currency to boost national foreign exchange reserves.
In contrast, the latest gradual depreciation in 2026 offers a more manageable environment for exporters to optimize their operations.
Unlike the chaos of 2022, this measured adjustment allows firms to forecast their costs with greater accuracy and adjust their global pricing strategies incrementally.
For high-growth sectors, a stable and gradually weakening rupee can provide a genuine competitive edge by increasing rupee-denominated revenue without the sudden shock of skyrocketing input costs.
However, the benefit remains a double-edged sword; if the depreciation leads to higher national electricity and fuel tariffs, it could still eat into the profit margins of energy-intensive industries.
Therefore, the long-term success of the export sector in 2026 will depend on whether this gradual depreciation is matched by gains in operational efficiency and a stable domestic policy environment.
Exporters are the only group of people that benefit from the gradual depreciation as their US dollar earnings yield more rupees, providing a buffer against local inflation.
IMF Deal
The ongoing IMF program relies on specific targets for debt-to-GDP ratios and primary surpluses.
A significant portion of Sri Lanka’s debt is denominated in foreign currency. As the rupee falls, the cost of servicing that debt in local currency terms increases, potentially blowing a hole in the national budget.
With the energy prices sky rocketing, the government has brought in subsidies to at least stop people from criticizing the government by not passing the real cost or market-reflective cost to the consumers. This is completely against the IMF deal.
If the government absorbs the cost of higher oil prices to protect the public, it risks violating IMF fiscal discipline targets and could delay the disbursement of next tranches.
Protecting Against Adverse Impacts
To survive a period of sharp currency depreciation, both households and companies must shift from a growth mindset to a preservation mindset, analysts say.
At the household level, people should hold a portion of savings in inflation-hedged assets like metals. Historically, gold or diversified unit trusts have performed better than simple savings accounts during depreciation.
It is also important to eliminate non-essentials in the household budget. They should focus on reducing energy consumption, as utility tariffs are highly sensitive to exchange rate movements.
They could shift to consume locally produced goods to avoid the import premium attached to foreign brands.
Another strategy, experts suggest, is to explore gig economy opportunities that pay in foreign currency, like freelancing and remote consulting, to create a natural hedge.
This may not be possible for everyone in the country, but Sri Lanka does not have a scarcity of talent and entrepreneurship to come up with innovative business plans to utilize resources to earn foreign currency in a gig economy.
At the company level, first, which are relying on imports, securing raw materials ahead of anticipated further depreciation can lock in costs while pivoting business models toward earning foreign exchange.
Even small-scale service exports can provide the necessary liquidity to cover domestic costs.
The local companies should also move away from variable-interest debt if a rate hike is expected, while renegotiating terms with suppliers to extend credit periods.
Companies may have to maximize their operational efficiency, such as implementing lean manufacturing or service delivery, to offset the rising cost of utilities and fuel.
-economynext.com
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