Reserve accumulation must not come at cost of economic stability says CBSL Governor

COLOMBO ‒ Sri Lanka cannot accumulate foreign exchange reserves through market distortions, money printing, or heavy foreign borrowing, but must build buffers before external shocks strike, Central Bank Governor Nandalal Weerasinghe said.

“For central banks, foreign reserves are far more than financial assets on a balance sheet. They are a country’s – a nation’s -first line of defence against external shocks,” Weerasinghe told a Reserve Management Conference in Colombo.

Foreign exchange reserves are a nation’s savings that provide vital time and policy space during a crisis, preventing disorderly economic corrections, Weerasinghe said, noting that Sri Lanka experienced this during its 2022 economic crisis when depleted buffers crippled imports, accelerated inflation, and triggered debt defaults.

While external balances have improved since 2023, rebuilding reserves is not linear because sudden shocks can quickly wipe them out.

Weerasinghe warned that rebuilding buffers requires discipline and cannot happen at any cost. Excessive market interventions distort price signals, monetary financing fuels inflation, and commercial debt creates future repayment burdens.

“A sustainable reserve accumulation strategy is not merely about acquiring reserves; it is about building an economy that naturally generates and retains foreign exchange,” he said.

Weerasinghe said reserve adequacy must move beyond simple months of import cover to assess debt servicing, volatile capital flows, and climate shocks.

He cautioned that portfolio diversification must not compromise liquidity, while citing bilateral support from the Reserve Bank of India during the crisis as vital regional resilience.

Treasurer, Asian Infrastructure Investment Bank (AIIB), Domenico Nardelli, who attended as the chief guest and delivered the keynote address, noted that reserve managers face sharp price swings even in safe assets like US Treasuries.

Nardelli dismissed claims of an imminent dollar collapse, noting it accounts for roughly 57% of allocated global reserves. While gold has hit record levels, he cautioned that it pays no yield and carries sharp price swings.

“Liquidity carries an inherent cost of carry. Rather than viewing this financing drag as lost yield, institutions must treat it as an essential insurance premium,” Nardelli said.

Citing historical merchant bank failures and the 2023 collapse of Silicon Valley Bank, Nardelli said holding ample liquid buffers buys critical time to reassure markets and manage unexpected cash outflows.

-economynext.com