to below 5 % by the turn of the century. the creation of “ a super welfare state ” in this manner without the backing of a proper resource base by sri lanka has been criticised by many as an unsound and unsustainable policy compared with that pursued by superperformers in the region. in this backdrop, some aspects of the welfare state were done away with in late 1970s when sri lanka moved to an open economy policy in which growth objectives were pursued through private sector participation and emphasis on export orientation. to facilitate the new growth strategy, economy was liberalised and a flexible exchange rate regime was followed. in the initial decade following the adoption of the new policy, economy responded positively, but at the same time, incidence of poverty too increased to a significant level 3. by mid 1980s, sri lanka ’ s two great chronicles, mahavansa and culavansa, have praised the kings who in fact followed this policy to the letter. the kings were guided mainly by kautilya who in his arthashastra advised the king to “ augment his power by promoting welfare of his people ” the arthashastra, penguin classics ( 1987 ), p 181. britain ’ s entry into a fully fledged welfare state was completed after the world war ii based on the beveridge report. for details, see, yergin, daniel & stanislaw, joseph, the commanding heights, ( 1998 ), p 6. for instance, poverty level as a percent of total population which stood at 19 % in 1978 - 79 rose to 27 % in 1986 - 87. saarc, meeting the challenge, ( 1992 ), p 5. it was felt that, unless an effective strategy is adopted to alleviate poverty among those who could not get integrated to the market economy policies, the country was within sight of another socio - economic explosion similar to the one which it experienced in 1971 in the near future 4. as a counter strategy, several poverty alleviation schemes were initiated by the government with focus on the poor. along with these schemes, the central bank too entered the foray by implementing some pilot projects based on microfinance and support services so that it could develop microfinance techniques and systems for others to emulate. one such project, funded by the international fund for agricultural development ( ifad ) and canadian international development agency ( cida ) was implemented by the central bank in four districts where the incidence of poverty was the highest under the title

buying and selling rates of foreign exchange, thus allowing freer foreign exchange transactions. the change in the exchange rate regime resulted in an overshooting effect with the rupee depreciating by rs. 13 from rs. 98 per us dollar within the first three days, but a relatively quick stabilisation of the exchange rate followed. as the use of monetary policy to defend the foreign exchange rate was no longer necessary under the floating exchange rate regime, the central bank of sri lanka was able to conduct monetary policy with an increased focus on achieving the bank ’ s objective of price stability. however, maintenance of price stability came under heavy pressure under this regime whenever aggregate demand was excessive as a result of expansionary fiscal policies. therefore, at times of such excessive domestic demand through fiscal dominance, the central bank of sri lanka intervened in the foreign exchange market to defend the exchange rate from depreciation. although this was done with the good intention of maintaining macroeconomic stability in difficult times, experience repeatedly showed that managing the exchange rate extensively was always associated with a substantial loss of limited international reserves followed by a large depreciation. the most recent of such events were in 2011 / 2012 and 2015. during the 2011 / 2012 episode, the central bank supplied us dollars 4. 2 billion to the market on a net basis, while the central bank supplied us dollars 3. 2 billion to the market on a net basis during the year 2015. in spite of these considerable losses of reserves, the rupee depreciated against the us dollar by 13. 5 per cent by the end of the 2011 / 2012 episode and by 9. 0 per cent during 2015. since then, the central bank has explicitly announced that international reserves will not be used to defend an overvalued exchange rate. instead, the central bank intervention in the foreign exchange market will aim to buildup international reserves. so far during 2017, the central bank has been able to purchase over us dollars 1. 3 billion from the market on a net basis for this purpose, and improved market confidence is shown by the limited depreciation of the currency this year. gradual modifications to the monetary policy conduct returning to the previous discussion, it was clear by late 1990s and early 2000s, that a serious rethink of central banking in sri lanka was necessary. in addition to the increasingly popular view within international central banking and academic circles that price stability must be the overriding objective of a central bank, financial innovations, including the development of electronic