• Govt. absorbs Rs. 20 b monthly as fuel costs surge
• Experts warn of stagflation risks without targeted relief
• ‘Tightrope walk’ between fiscal discipline, social stability
• IMF review underway as SL seeks flexibility amid crisis
• Limited fiscal space restricts Govt.’s ability to cushion impact

Sri Lanka’s fragile energy sector is once again being tested by forces largely beyond its control, as global geopolitical tensions feed directly into domestic pricing pressures and fiscal strain.

Under the $ 3 billion programme with the International Monetary Fund (IMF), the country is required to maintain cost-reflective pricing for both fuel and electricity, a key structural benchmark aimed at preventing the re-emergence of unsustainable subsidies that contributed to the economic collapse.

However, the recent escalation of conflict in the Middle East following the Iran war has disrupted global energy markets, driving up fuel costs and complicating the Government’s reform trajectory. In March, fuel prices were increased by between 26% and 30%, a move that has had immediate knock-on effects on electricity generation.

Despite an electricity tariff revision that came into effect on 1 April, economists and experts argue that the increase, estimated at between 10% and 13.5%, falls short of reflecting the true cost of generation. This gap has effectively reintroduced a form of indirect subsidy, raising concerns about compliance with IMF conditions and the sustainability of the current pricing model. 

The Ceylon Electricity Board’s (CEB) successors, facing sharply higher fuel costs without a proportional rise in revenue, are incurring mounting losses. These losses ultimately translate into a burden on the Treasury, widening the fiscal deficit at a time when the Government is under pressure to maintain a primary surplus.

Cabinet Spokesperson, Minister Nalinda Jayatissa acknowledged the scale of the burden, stating that the Government was absorbing approximately Rs. 20 billion per month at present to cushion fuel costs. 

According to him, the State is effectively subsidising around Rs. 100 per litre of diesel and Rs. 20 per litre of petrol. He warned that fully absorbing fuel costs would add an estimated $ 1.5 billion annually to public expenditure, a level widely considered untenable given existing fiscal constraints.

Meanwhile, Public Utilities Commission of Sri Lanka (PUCSL) Chairman Lalith Chandralal has indicated that further tariff revisions may become unavoidable. He noted that if fuel price increases were to push electricity costs up by more than 15%, a fresh tariff submission would be required to remain aligned with cost-reflective pricing principles.

This places the Government in what economic analysts describe as a precarious balancing act – attempting to adhere to IMF-mandated reforms while mitigating the social fallout of rising living costs.

Current visit of IMF delegation

An IMF staff team visited Sri Lanka on 26 March and will continue its visit until 9 April to hold discussions with the authorities on the combined Fifth and Sixth Reviews of Sri Lanka’s reform programme supported by the IMF’s Extended Fund Facility (EFF).

The delegation met President Anura Kumara Dissanayake on Thursday (2) and also held discussions with party leaders in Parliament on the same day. The team met with President Dissanayake at the Presidential Secretariat to discuss Sri Lanka’s ongoing economic reform programme and progress under the IMF-supported EFF.

During the discussions, attention was drawn to the current status of Sri Lanka in relation to the Fifth and Sixth Reviews of the IMF programme, with the delegation engaging the President on recent developments and progress achieved.

Discussions also focused on how Sri Lanka could continue to advance within the IMF programme without undermining the economic stability that has been established thus far. It was further noted that the ongoing conflict in the Middle East posed an external challenge, the impact of which could not be entirely avoided. 

However, the Government has been managing the situation prudently, taking measured decisions to address pressures on fuel prices and the energy sector while ensuring that targeted relief is provided to vulnerable groups, according to the President’s Media Division (PMD).

Responding to the IMF’s observations, President Dissanayake stated that Sri Lanka had met all targets set under the programme and had reached a position of relative stability. He highlighted the need to take all necessary measures to minimise the impact on the public.

The IMF will announce its stance after concluding the visit on Thursday (9).

A tightrope walk

Speaking to The Sunday Morning, former Deputy Governor of the Central Bank of Sri Lanka (CBSL) Dr. W.A. Wijewardena offered an assessment of the Government’s current economic position, describing its attempt to satisfy IMF conditions while containing public hardship as a precarious balancing act.

According to Dr. Wijewardena, the administration is caught between two competing pressures. On one side are the IMF’s requirements for market-based pricing in fuel and electricity, and on the other is the political and social reality that sharp price increases could trigger serious public backlash. 

He likened the Government’s approach to that of a tightrope walker, carefully trying to maintain balance between economic reform and the risk of social disorder.

At the centre of this dilemma is the cost of maintaining subsidies, even in a limited form. Dr. Wijewardena noted that the current energy subsidy was costing the State around Rs. 20 billion per month, a figure he indicated was far too high to be sustained over time. 

While the Government may see such interventions as necessary to cushion the public from the full impact of rising fuel and electricity costs, he made it clear that this came at a heavy fiscal price.

Dr. Wijewardena also stressed that Sri Lanka’s present crisis could not be viewed purely as a result of domestic policy choices. In his view, the country has been hit hard by an external shock, driven by global conflict and volatility in international energy markets. 

He argued that institutions such as the IMF and the World Bank understood that Sri Lanka was, in many respects, “an innocent bystander who gets hit while standing on the side” of these global events.

Because of this context, he suggested that the IMF had not taken an excessively punitive approach in this instance.

“The IMF is not implementing its conditions harshly in these instances,” he said, adding that the institution appeared to be looking at Sri Lanka’s position with a degree of empathy. 

Even so, he cautioned that such understanding did not mean the country had room to walk away from its commitments. Sri Lanka, he said, still “cannot deviate from the conditions set by the IMF” given the fragility of its economic recovery.

A major concern, according to Dr. Wijewardena, is that the Government has now exhausted its fiscal space. In practical terms, this means there is little or no room left in the budget to absorb further economic shocks. The State no longer has the flexibility to respond freely to price surges or expand spending without risking further instability.

He also pointed to the limits of the public’s capacity to shoulder additional burdens. With Value-Added Tax (VAT) standing at 18% and income taxes reaching 36%, Dr. Wijewardena noted that the Government could not realistically expect citizens to pay more.

“People do not have the ability to pay more than 36% in taxes,” he observed, noting that public frustration over the tax burden was already evident. At the same time, traditional revenue sources have weakened, including Customs income from motor vehicle imports, leaving the Government with fewer avenues to raise money.

Within this difficult landscape, Dr. Wijewardena identified one particularly significant feature of the current IMF arrangement. Unlike many foreign loans, which are usually channelled to the Central Bank to build reserves, these funds flow directly into the Government’s budget. 

He described this as a special case and even a special blessing, because it gives the Government immediate liquidity to finance expenditure and keep the machinery of the State running.

In his view, this direct budgetary support is one of the key reasons the Government has been able to function within its current constraints. Without it, he suggested, there would be no meaningful way for the State to manage its obligations under the existing fiscal framework.

Taken together, Dr. Wijewardena’s assessment is that Sri Lanka is trying to navigate an exceptionally narrow path, meeting IMF reform demands, absorbing the fallout of global energy shocks, and avoiding a level of social pain that could destabilise the recovery itself. The problem, he indicated, was that the longer temporary subsidies continued, the more difficult that balancing act would become.

Balancing structural reform with sector survival

As Sri Lanka continues negotiations with the IMF, the Government is increasingly being forced to reconcile strict fiscal targets to adhere to the current programme. Despite this, the Government remains hopeful of a positive outcome from the negotiations.

Deputy Minister of Industry and Entrepreneurship Development and Committee on Public Finance (COPF) member Chathuranga Abeysinghe said that the central objective of the IMF agreement was to prevent the accumulation of further State debt, particularly through loss-making State-owned enterprises.

“The agreement we have with the IMF is that the Treasury will not be burdened by energy costs and that it won’t go into State debt,” Abeysinghe said, noting that there remained room for negotiation within that framework.

“We can negotiate with them until then. For example, if a loss of Rs. 31 billion comes to the CEB successors, if we agree with the IMF on that amount – the portion the Government puts in from the total budget – they won’t have a problem.”

However, he made it clear that the IMF’s insistence on cost-reflective pricing inherently created a fluctuating pricing environment for both consumers and businesses.

“Because the agreement is there that it must be cost-reflective, if the cost increases further, we must go for a price adjustment,” he explained. “Price adjustments will happen continuously, month by month. If we can manage this annually without harm to the people, it won’t conflict with the IMF.”

Against the backdrop of rising global energy prices, Abeysinghe revealed that the Government was seeking to build a financial buffer to absorb shocks and stabilise the system.

“Because of this crisis, we have made some requests to the IMF for negotiation,” he said, indicating that the Government was attempting to frame the current situation as an extraordinary one in order to secure flexibility.

“In a crisis, some conditions do not apply according to the agreement. We have to show this as an extraordinary situation, similar to the situation where they gave us support during crises like Cyclone Ditwah.”

Possible economic consequences 

While policymakers focus on maintaining compliance with IMF benchmarks, economists warn that rigid adherence without adequate safeguards could have severe consequences for the real economy.

University of Colombo (UOC) Department of Economics Professor Priyanga Dunusinghe cautioned that the current trajectory risked pushing Sri Lanka towards a serious crisis, with the potential emergence of stagflation, a scenario characterised by stagnant growth combined with rising prices.

“If the Government doesn’t talk to the IMF and go for some relief, this journey will lead to a serious crisis. It will be pushed into what I call stagflation,” Prof. Dunusinghe warned. “That is highly damaging and can have a lot of social and economic implications.”

Despite acknowledging that cost-reflective pricing was sound in principle, he questioned its application under present conditions of economic strain.

“Cost-reflective price handling is very good as a principle. We should pay according to the cost,” he said. “But in a situation where prices are rising further from where they are now, going for cost-reflectivity is problematic. We don’t have a guarantee that high-income earners use this fuel in productive sectors.”

He stressed that policy must distinguish between productive and non-productive consumption, urging the Government to prioritise fuel allocation to sectors that directly contributed to economic output.

“The Government must definitely ensure the supply of the necessary amount of fuel to essential production areas in industrial, agricultural, and service sectors,” he said. “If diesel rises to Rs. 600, a farmer won’t cultivate again. These things must be taken into consideration.”

Speaking further, Prof. Dunusinghe emphasised that macroeconomic targets alone could not define recovery if the productive base of the economy was weakened in the process.

“I think it’s possible [to negotiate]. If not, and if the economy collapses, all other macroeconomic indicators will definitely deteriorate. If those deteriorate, we will erase any progress we have made,” he said.