Monetary Policy and Market Stability: Why Interest Rates Stayed Flat Despite a Weaker Rupee

By -

Title: Sri Lanka rupee weakens against dollar, bonds flat

Date of Publication: Friday, July 18, 2025, 5:08 PM

Source: EconomyNext- http://www.economynext.com/

By K.M.S.K. Herath –(236047D)


Brief Summary

July 18, 2025, was one of those days when Sri Lanka's financial market had reflected prudent stability. The rupee depreciated very little compared to the US currency, while government bond yields remained unchanged, indicating firm investor confidence. This is indicative of Keynes' Liquidity Preference Theory that interest rates equilibrate when cash holdings and investment in bonds are in equilibrium. The fact that there were no dramatic changes in bond yields is indicative of equilibrium between money demand and money supply. Additionally, this tranquility represents investor trust in the Central Bank's monetary strategy, with no anticipation of prompt alterations. Even with slight exchange rate fluctuations, the market stayed stable without major changes to interest rates. This scenario demonstrates how economic theories can provide context for actual occurrences, delivering understanding of market equilibrium and investor trust. The market's behavior frequently showed a sense of steady confidence rather than fear.
People trade currencies, stocks, and bonds on financial markets, which helps the economy expand by distributing funds where they are required. In Sri Lanka, opinions on inflation and public finances appear in the government bond market. Recently, the rupee fell slightly due to external issues, but stable bond interest rates show domestic stability. This balance boosts investor confidence and supports the economy.

How Are Interest Rates Determined?

     


Interest rate is a rate of the sum of principal which a lender is demanding for use of its funds or which a financial institution is paying on funds saved or invested, as cost of borrowing or yield on saving

Under the Interest Rate Determination, there are two main frameworks:
Liquidity Preference Theory (LPT) and Loanable Funds Theory (LFT).

1.     Liquidity Preference Theory (LPT)

Liquidity Preference Theory, developed by Keynes, explains that interest rates are set by money demand and supply; higher rates encourage investment by compensating for liquidity preference. Equilibrium is at a supply and demand balance.

On 18th July 2025, the financial market of Sri Lanka was stable.  The rupee slightly fell against the US dollar, and bond rates were marginally unchanged. This indicates that individuals' actions remained fairly consistent, they weren’t attempting to acquire more money or invest rapidly. The money market remained steady.

 


Image from: https://www.economicsonline.co.uk/definitions/liquidity-preference-theory-with-graphs.html/


2.     Loanable Funds Theory (LFT)

The Loanable Funds Theory states interest rates arise from the supply of savings and demand for borrowing, influencing borrowing costs through their interaction.

In this situation, interest rates stabilized since government and business lending did not rise, personal saving remained constant, and rupee fell marginally.


  

Image from: https://www.economicsonline.co.uk/definitions/loanable-funds-theory.html/

 

The Central Bank of Sri Lanka's (CBSL) Role


In May 2025, the Central Bank of Sri Lanka focuses its monetary policy decisions on the 7.75% Overnight Policy Rate (OPR).The CBSL can increase the OPR to increase borrowing costs and cut spending in order to address the rising rate of inflation. A slowing-down economy will lead to the CBSL lowering the OPR to boost spending and borrowing. Currently, the OPR is stable with no yield volatility in government securities against a marginal devaluation of Sri Lanka's rupee, demonstrating investor faith in the monetary policy.

                                                                                                                                                                          


         Image from: https://www.hirunews.lk/en/business/290851/notice-from-cbsl-for-those-who-possess-foreign-currency

 

Conclusion                  

The monetary policy is regulated by the Central Bank of Sri Lanka via the Overnight Policy Rate (OPR) of 7.75% as of May 2025. To counter inflation, which is on the rise, the CBSL can hike the OPR to raise the borrowing rate and lower spending. A slowing economy will lead the CBSL to lower the OPR to boost spending and borrowing. Now, the OPR is steady with no volatility in the government securities' yield for a mild devaluation of Sri Lanka's rupee, demonstrating investor faith in monetary policy.

 

References

https://economynext.com/sri-lanka-rupee-weakens-against-dollar-bonds-flat-231516/

https://www.fe.training/free-resources/financial-markets/determination-of-interest-rates/

https://www.investopedia.com/terms/l/liquiditypreference.asp#:~:text=Liquidity%20preference%20theory%20says%20that,payment%20for%20parting%20with%20liquidity

https://www.economicsonline.co.uk/definitions/loanable-funds-theory.html/

https://www.cbsl.gov.lk/sites/default/files/cbslweb_documents/press/pr/press_20250522_Monetary_Policy_Review_No_3_2025_e_Mw8b9.pdf

Lecture Note: Topic 4 – Interest Rate Determination (IM2231)

Comments

Post a Comment

Popular posts from this blog

Welcome to Our Blog - A Journey into Sri Lanka's Financial Markets and Institutes

By -
Image
  Hello everyone!  We warmly welcome you to our finance blog website," The Finance Ledger ",where we dive into the heart of Sri Lanka's financial system. Before we begin our journey into the Financial markets and institutes in Sri Lanka, we would like to introduce ourselves. We are a group of undergraduates with a shared interest in financial markets and institutions,especially in Sri Lanka. The aim of our website is to breakdown current finance news and trends for individuals to better understand.Further,we will be integrating our own financial insights into the blogs,making them more understandable for the reader.We will be covering from financial markets such as equity and debt markets, along with financial instruments like share,bonds and bills.  This is only the beginning and stay tune for our financial journey!    "Exploring finance, one week at a time" Members of Group 04  
Read more

Redefining Finance: The Rise of Non-Banking Financial Institutions in Sri Lanka

By -
Image
Non-Banking Financial Institutions (NBFIs) have become a transformative force within Sri Lanka’s financial sector, which offers a wide range of financial services outside the traditional banking sector. These NBFIs do facilitate alternative financial services, such as investment (both collective and individual), risk pooling, financial consulting, brokering, money transmission and check cashing.                             Image from https://www.investopedia.com/terms/n/nbfcs.asp Understanding the difference between banks and NBFIs Banks are licensed financial institutions authorized to accept deposits and provide a broad range of financial services such as loans, maintain current and savings accounts and do foreign exchange transactions. They are strictly regulated by the central bank of Sri Lanka subject to hig...
Read more

Importance of Financial Institutions and Markets : Bringing Back Investor Confidence

By -
Image
Colombo Stock Exchange (CSE) Reached Its Peak  Image from https://www.cse.lk As we all know, Sri Lanka is still recovering from its recent financial crisis. Earlier this week, there were some positive developments in the financial markets, especially in the stock market. On June 30th, the All Share Price Index (ASPI) of the Colombo Stock Exchange (CSE) reached a stunning figure of 18,026.72 points, as reported by Sirasa Newsfirst. The total turnover for the day was around Rs. 6.3 billion. According to the official CSE website, the ASPI reached its highest point of 18,148.34 on July 4th. This indicates that investors have regained confidence in companies, expecting high returns from them. ASPI chart from   https://www.cse.lk For those who are new to finance, you might ask: Why are financial markets important, and how can they uplift the economy? Don't worry,in this blog, I will be covering the importance of financial markets and institutions What Are Financial Markets?  B...
Read more