Fuel subsidies are not social protection

By Dhananath Fernando

Originally appeared on The Morning

This column previously warned that when prices lie, crises follow. Sri Lanka learnt that lesson the hard way in 2022. Yet today, we are once again moving towards the same dangerous path by moving away from cost-reflective fuel pricing.

The Government has now effectively admitted that fuel is being subsidised by around Rs. 100 per litre for diesel and around Rs. 20 per litre for petrol. Sri Lanka consumes roughly 180 million litres of diesel a month and a similar volume of petrol. Even if this subsidy applies only to fuel sold through the State-owned Ceylon Petroleum Corporation (CPC), the cost is staggering. The monthly subsidy bill could easily exceed Rs. 15 billion and amount to Rs. 150–200 billion annually.

To put that into perspective, Rs. 200 billion is equivalent to building nearly two expressway phases of Rambukkana to Galagedara or financing several major infrastructure projects. Instead, we are distributing that money through subsidised fuel largely to those who consume the most energy.

The reality is simple. The non-poor consume far more fuel than the poor. Around 70% of Sri Lanka’s fuel consumption comes from higher-income groups and commercial users who are relatively capable of absorbing price increases. In effect, the subsidy becomes a transfer of public money to people who can already afford to pay market prices.

The bigger issue

The President recently stated at a meeting that, according to CPC calculations, diesel prices should be around Rs. 720 per litre, while it is currently being sold at around Rs. 392. Even after accounting for the estimated Rs. 100 subsidy, there still appears to be a significant gap between the actual cost and the selling price.

The bigger issue, however, is not merely the subsidy itself but the pressure it creates across the entire economy. The President himself acknowledged that Sri Lanka’s monthly fuel import bill, which was previously around $ 200–300 million, was now expected to rise towards $ 500 million.

Artificially low prices encourage higher consumption, especially among those who can afford it. The likely Government strategy may be to hold prices down temporarily in the hope that global oil prices will eventually decline, allowing losses to be recovered later. Unfortunately, this is exactly the same mistake Sri Lanka made before the economic crisis.

Fuel and electricity were both sold below cost for prolonged periods based on political calculations rather than economic reality. Once subsidies are introduced, politics makes it extremely difficult to reverse them. Politicians facing elections and public pressure continue postponing necessary price adjustments, and temporary subsidies slowly become permanent fiscal burdens.

Severe consequences

The consequences do not stop there. Fuel and vehicle-related taxes remain among the Government’s largest sources of revenue. With vehicle imports already constrained, the resulting tax shortfall will eventually need to be filled either through new taxes, lower tax thresholds, or wider tax collection efforts.

It is far more transparent and economically rational to allow consumers to pay the true market price for fuel at the point of purchase rather than recovering the same money later through additional taxes on income, consumption, or businesses.

Sri Lanka’s agreement with the International Monetary Fund clearly emphasises the importance of cost-reflective pricing for fuel and electricity. Even if the Government argues that subsidies can be financed through alternative revenue streams, the signal sent to investors, businesses, and international lenders is deeply concerning. It suggests that Sri Lanka is beginning to drift away from the very stability framework that restored confidence after the crisis. The same concerns apply to delays in electricity tariff revisions.

There is also a dangerous monetary risk beneath the surface. Subsidising fuel for those who do not need support eventually creates pressure on the Government to seek financing elsewhere. Historically, that ‘elsewhere’ has often been the Central Bank.

Today, with greater Central Bank independence, direct monetary financing is no longer easily possible. But political pressure can quickly emerge to weaken those safeguards. Once people are convinced that printing money can keep fuel prices low and distribute more subsidies, the pressure to dilute hard-earned reforms becomes politically attractive. That is precisely how Sri Lanka entered the spiral that led to the 2022 collapse.

Without some level of demand contraction through market pricing, fuel consumption will continue increasing, placing greater pressure on the dollar market. Sri Lanka will then face two painful choices: allow the rupee to depreciate sharply or spend down scarce foreign reserves defending the currency.

Both options carry severe consequences. A weaker rupee pushes inflation and fuel prices even higher, creating a vicious cycle. Meanwhile, depleting reserves damages investor confidence, weakens creditworthiness, and raises concerns about debt sustainability.

None of this means high fuel or electricity prices are desirable. Prices should come down. But sustainable price reductions can only come through productivity improvements, competition, efficiency gains, and better management, not through unsustainable subsidies.

At the same time, rising energy prices do hurt the poorest households disproportionately. The solution, however, is not universal subsidies that benefit the wealthy most. The correct approach is targeted social protection. Sri Lanka must strengthen its social safety nets and increase direct cash transfers for the poorest families rather than subsidising fuel consumption for those who can comfortably afford market prices.

In simple terms, subsidies should protect the poor, not cheap fuel consumption for the rich.

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From airlines to electricity: The cost of ignoring markets

By Dhananath Fernando

Originally appeared on The Morning

Last week offered two clear reminders of a lesson Sri Lanka keeps learning the hard way.

Markets discipline decisions. Governments struggle to run businesses. The cost of ignoring this distinction is paid by taxpayers and consumers.

SriLankan: A repeating cycle

The first story was the resignation of the Chairman and several board members of SriLankan Airlines. This is not a story about individuals failing. It is a story about systems failing. Even capable professionals cannot succeed when incentives, governance, and political pressures are misaligned.

We have seen this cycle before. Successive governments have been persuaded that the airline can be ‘turned around’ with the right people and a new plan.

When the current President assumed office as both President and Finance Minister, his first Budget allocated Rs. 20 billion to support the airline based on the board’s recovery plan. Eighteen months later, we have not even managed to appoint a permanent CEO to run a highly technical, fast-moving industry that depends on precision and commercial agility.

This is not new. As far back as the time of J.R. Jayewardene, advice from Lee Kuan Yew was clear: do not run an airline as a state enterprise. Singapore structured its National Carrier under Temasek Holdings, separating ownership from political control and embedding commercial discipline.

Sri Lanka has done the opposite. From one administration to another, the pattern has been the same. Political ownership, weak governance, and repeated capital injections. The debt of roughly $ 510 million was absorbed by the Government, transferring the burden from the airline’s balance sheet to the public. Yet the core problem remains unresolved.

Every new board arrives with a familiar script. Fleet expansion. Optimistic projections. A promise that the airline is ‘rescuable’. But without basic building blocks such as professional management and independence from political interference, these plans collapse. If a government cannot appoint a CEO for its own airline, it raises a more fundamental question. Can the State effectively run any commercial enterprise?

Today, there is discussion of injecting another Rs. 20 billion as the airline struggles to remain a going concern. This is the trap of State ownership. Entering is easy. Exiting is nearly impossible. Selling is politically sensitive. Closing is economically disruptive. The result is a perpetual drain on public finances.

Energy pricing: The real risk

The second story was the electricity tariff revision. It is understandably unpopular, but the real risk lies not in raising prices but in failing to do so.

Energy pricing in Sri Lanka has long been disconnected from market realities. When global prices rise and domestic tariffs remain unchanged, the losses accumulate within institutions such as the Ceylon Petroleum Corporation. These losses do not disappear. They are financed through borrowing, money printing, or delayed payments, all of which eventually return to the public in the form of inflation, currency depreciation, or shortages.

At present, diesel pricing illustrates the problem clearly. Based on current global prices, diesel is being sold at a significant loss, estimated at around Rs. 163 per litre. Even if the Government were to remove the entire tax component, there would still be a gap. This is not sustainable.

Meanwhile, private players such as Lanka IOC and Sinopec are operating under the same administered pricing structure. The sharp increase in super diesel prices to around Rs. 600 signals that underlying costs are much higher than the retail price of standard diesel.

At the refinery level, the difference between diesel and super diesel is relatively small, often in the range of $ 0.05–0.15 per litre. In rupee terms, this would typically translate to a gap of around Rs. 45–50. The current price difference of nearly Rs. 190 suggests that standard diesel prices are significantly underpriced.

Underpricing has consequences. It creates implicit subsidies that are neither targeted nor efficient. In Sri Lanka, around 70% of fuel is consumed by the wealthiest 30% of the population. When diesel is sold below cost, the benefit disproportionately accrues to those who consume more, while the cost is borne by the broader population.

This is why the real conversation should shift. While prices must be adjusted to reflect market realities, the policy effort should focus on strengthening the social safety net. The objective is not to suppress prices artificially, but to protect the most vulnerable directly.

We cannot protect the poorest of the poor by keeping prices low. In fact, rising food prices, especially of essentials like rice, have already hit them the hardest. Broad subsidies on fuel do little to help them. Instead, they drain public resources.

The better approach is targeted support. Increase cash transfers to the poorest households so they can weather this period of high prices. Strengthen the social registry. Improve targeting. Ensure that assistance reaches those who genuinely need it, rather than being spread thinly across the entire population.

This also preserves fiscal space. Instead of subsidising consumption for higher-income groups, resources can be redirected to those who are most vulnerable. It is both economically efficient and socially just.

The link to electricity is direct. As water levels decline and hydro generation falls, the system shifts towards thermal power, relying on diesel and coal. If diesel prices remain artificially low, the losses in the energy sector widen. If prices are corrected, electricity tariffs must adjust accordingly. The alternative is power cuts or a return to the fiscal and monetary instability that triggered the last crisis.

The uncomfortable truth is that market-reflective pricing is not a choice. It is mandatory. Ignoring it does not protect consumers. It postpones the cost and amplifies it.

The high price of ignored signals

Both stories from last week point in the same direction. Governments are not designed to run commercial enterprises. When they try, inefficiencies and losses accumulate. Prices that ignore market signals create distortions, shortages, and fiscal pressure.

The solution is not complicated, though it is politically difficult. Exit from commercial activities where the State has repeatedly failed. Establish clear, rules-based pricing mechanisms for energy that reflect global costs. At the same time, build a stronger, better targeted social safety net that protects the poorest from the impact of these adjustments.

Markets are not perfect. But they are far better at signalling reality than administrative decisions. When those signals are ignored, reality eventually asserts itself, often at a much higher cost.

(The writer is the Chief Executive Officer of Advocata Institute. He can be contacted via dhananath@advocata.org)

(The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute)