"The lifting of value added tax cost a further Rs7 billion."

The Finance Ministry now says the Rs32 billion could have been better spent on development activities and uplifting the poor.

In 2004, the current ruling coalition won a general election with the support of the Marxist-nationalist Janatha Vimukthi Peramuna (JVP) on a promise to subsidize fuel.

The policy, widely popularized as 'removing the plug,' promised to insulate Sri Lanka against the forces of international market forces.

In 2004, the government used central bank credit to pay for fuel subsidies, instantly plunging the country into a balance of payments crisis and driving consumer inflation up to 18 percent by the end of the year.

The subsidy policy also discouraged fuel conservation and promoted rampant consumption.

The Finance Ministry says in 2003 the government spend US$750 million on oil imports, in 2004 US$1200 million and in 2005 US$ 1600 million.

Oil prices are now touching US$70 a barrel from around US$53 a barrel in April 2004.

In the recent local government elections, the JVP which contested on its own, suffered a major setback winning a solitary local body which it held previously, and the ruling UPFA coalition of President Mahinda Rajapakse recording a sweeping victory.

Sri Lanka abandoned an automatic pricing formula in late 2003 amidst political instability.

"If fuel prices had been allowed to change petrol prices would have gone up to Rs85 a litre, diesel to Rs57 and kerosene to Rs60," Finance Ministry said.

Petrol now retails at Rs80 a litre and diesel Rs50 a litre and super diesel Rs55 a litre.

Kerosene prices have been traditionally kept low based on the premise that it is used by low income classes.

Sri Lanka also follows a policy of keeping diesel prices lower than petrol.

Petrol is heavily taxed with a variety of excise, import duties and value added taxes while diesel prices are kept low, with value added tax also being lifted just before the presidential elections last November.

While ordinary Sri Lankans using petrol-driven motorcycles and small cars pay a high price for their fuel, the richer section of society, (including politicians who are entitled to duty free vehicles) use the cheaper diesel to drive around in fuel-guzzling sport utility vehicles.

"To keep the fuel prices at the current level the government [finances] has to bear a huge burden," the Finance Ministry said.

"Last years Rs25 billion fuel subsidy is more than the money required to build the Colombo-Katunayake Expressway. If these resources could be re-directed towards development spending, we would not have to take loans from foreign countries."

The Katunayake expressway is being built with Chinese aid.

The government also owes more than Rs7 billion in unpaid subsidies to Lanka IOC, a unit of Indian Oil Corporation, which is the country's second fuel retailer.

Multilateral agencies, such as the World Bank has been trying to educate the government that most of the fuel subsidies in fact went to higher income classes.

In Sri Lanka the bulk of petrol and diesel is sold in the Western Province, where poverty is only 6-percent.

-Asantha Sirimanne: asantha@vanguardlk.com