Sri Lanka's central bank creates money through dollar purchases to maintain a de facto peg to the US dollar through its foreign exchange operations, though there is an overall commitment to maintain a 'flexible' exchange rate or a looser peg since the last balance of payments crisis.
On Wednesday unsterilized dollar purchases pushed excess liquidity to 46.1 billion rupees from 9.1 billion rupees a day earlier.
The excess clearing balance is close to 10 percent of the current domestic monetary base.
The central bank temporarily mopped up cash overnight through a 36 billion rupee repo auction while the balance went to the standing repo facility.
To clear the existing spike in excess liquidity and maintain the exchange rate the Central Bank will either have to engage in unsterilized dollar sales in the coming weeks or kill domestic credit through a sell down of Treasury bills (a sterilized purchase of forex).
On January 17, a 12.5 billion rupee term auction injections matured and was not rolled over, indicating a sterilized foreign exchange purchase.
Last year term money was given to bank below the Central Banks overnight policy rate halting an appreciation of rupee and undermining the credibility of the peg.
On Friday the Central Bank announced two term auctions of 10 and 20 billion rupees to withdraw liquidity.
The 10 billion rupee repo auction would mature on February when a 10 billion rupee reverse repo injection is also due to mature.
The ending of the two term reverse repo injections would allow the Central Bank to lock up nearly 200 million dollars of foreign reserves and also create a 'shortage of rupees' allowing the exchange rate peg to remain strong or appreciate.
In the short term however the rupee has remained volatile amid excess liquidity.
On Thursday the rupee weakened below 126.80 to be quoted almost at 90/figure levels, when selling by commercial banks halted the slide.
From late December the rupee strengthened against the dollar falling briefly topping 126 rupees to be quoted around 125.90 rupees.