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.

Graph