Sri Lanka has cut the reserve ratio by a total of 225 basis points in October and again in November releasing tens of billions rupees to banks, but the liquidity disappeared swiftly in the face of a soft-peg defence exercise.

But lower reserve ratios allow banks to lend more of the deposits they collect improving the efficiency and profitability of the banking system.

"It is expected that this measure, together with the measures adopted by the Central Bank in the recent past, would mitigate the negative consequences of the global credit crunch on the domestic economy," the Central Bank said in a statement.

The Central Bank said policy rates had also been brought down to bring down market interest rates.

In the Interbank market the gross shortage of reserves hit 21 billion on Tuesday. Large liquidity shortages are generated by dollar peg defence, and signal an outflow of foreign reserves.

In forex markets the rupee hit a low of 114.50 in tom trades (transactions that are settled a day later) though a state bank that usually acts for the monetary authority was offering dollars at 113.85 in the spot (settled two days later) market.

From September to December, Sri Lanka's official reserves have halved from 3.4 to 1.7 billion dollars.

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