When prices lie, crises follow

By Dhananath Fernando

Originally appeared on The Morning

The only certainty about the crisis in the Middle East is its uncertainty. Recent attacks on Iranian and Qatari gas infrastructure are already pushing global Liquefied Natural Gas (LNG) and energy prices upwards, and these pressures are unlikely to ease anytime soon.

Many Sri Lankans fear that our economy could collapse because of this crisis. There is some truth in that concern. But if the economy does collapse, it will not be because of the Middle Eastern crisis alone; it will be because of how we respond, or fail to respond to it.

At the heart of this response lies one critical decision: whether we adjust domestic energy prices in line with global realities.

In his address to Parliament on Friday (20), the President signalled the need to revise fuel prices again mid-month. Given the volatility of global markets, even weekly or daily revisions may be justified. This is not policy overreaction; it is economic discipline.

Prices are the most effective tool we have to manage scarcity. When prices rise, demand contracts – that is how markets signal reality. With global energy prices skyrocketing, price adjustments are not optional; they are the first line of defence.

Yet, the pressure to increase prices remains politically constrained. Sri Lanka currently has a degree of buffer, both in foreign reserves and domestic liquidity. This creates the illusion that we can delay adjustments. Governments often hesitate, fearing the political cost of passing global price shocks to consumers.

Keeping prices artificially low, however, has consequences. It encourages consumption beyond what we can afford. Every litre consumed above sustainable levels is paid for with scarce dollars. Eventually, this pressure will hit the exchange rate.

At that point, the Government will face an even harsher choice: either allow the rupee to depreciate sharply, or burn through reserves to defend it. Both paths are far more damaging than timely price adjustments.

If we choose to defend the currency while keeping fuel prices artificially low, we will simply deplete our reserves. If we float the currency under pressure, the impact will be economy-wide higher inflation, eroded savings, and a deteriorating investment climate.

None of these are better alternatives.

That said, fuel price hikes are not painless. They are not a perfect solution, nor a silver bullet. Higher fuel prices will ripple across the economy; raising transport, food, and other essential costs. Given the relatively inelastic nature of fuel demand, the burden will be felt widely, especially by the poorest.

This is precisely why price adjustments must be accompanied by targeted cash transfers. The answer is not to suppress prices for everyone, but to support those who truly need it. Well-targeted assistance can cushion the vulnerable without distorting the entire system.

It is also important to understand this: even if fuel prices rise to Rs. 1,000 in line with global markets, the economy will adjust. Growth may slow, but stability will be preserved.

The alternative, on the other hand, is far worse. If we avoid price adjustments, the gap between real costs and subsidised prices does not disappear, it accumulates. And eventually, society pays the price through currency depreciation, inflation, and another full-blown economic crisis.

We have seen this movie before.

The decision to allow private companies to import fuel is a step in the right direction. The President noted that five licences had already been issued. These players will likely enter the market at higher, more realistic prices. That, in itself, is a signal.

Higher prices attract supply. They also discipline demand. Both are necessary in a constrained environment.

Our hard-earned reserves should not be used to defend an artificial exchange rate. Nor should our hard-earned primary surplus be used to subsidise fuel consumption, especially when, as data suggests, nearly 70% of fuel is consumed by the top 30% who can afford higher prices.

Even mechanisms like the QR code system are, in effect, hidden price controls. Long queues, waiting time, and even informal payments to bypass quotas are simply non-monetary forms of price increases.

If we are serious about reform, we must go further. Price caps imposed on private players such as Sinopec, Lanka IOC, and Shell should be removed. These companies must have the incentive to import and supply fuel based on market conditions. Ceylon Petroleum Corporation (CPC) prices, too, must adjust accordingly.

The real test for the Government is simple: can it allow prices to reflect reality?

If it fails, the Middle Eastern crisis will not remain external; it will become our own economic crisis.

If it succeeds, the economy may slow, but it will endure.

And in times like these, survival with discipline is far better than collapse with denial.