Sri Lanka's forex markets are now shallow after the Central Bank cut net open positions of banks, a usual practice that has increased volatility in previous balance of payments crises as well.

Dealers say some banks started to sell dollars as the implied interest yield on swaps rose as much 11.70 percent for a month. There were also more remittances awaiting conversion after holiday.

However there were no buying from importers who earlier covered at higher prices and were expecting the rupee to fall further following Treasury secretary P B Jayasundera's statements that the rupee would eventually settle around 125 to the US dollar.

The rupee rose in small deals and then fell from 125.50/126.25 levels towards 127.50 in just two deals, reflecting unusual volatility, dealers said.