"The government advised us to reduce the price of diesel, so we have done that," Lanka IOC managing director K Ramakrishnan told LBO.
LIOC on Tuesday cut the price of its diesel by 10 rupees to 120.
It had earlier raised it to 130 rupees, 20 rupees more than that of the CPC after the government imposed a tax on imports of petrol.
The move prompted the government to order LIOC to sell diesel on par with state-run Ceylon Petroleum Corporation or face sanctions.
Lanka IOC raised the price of diesel by 20 rupees to 130 rupees a litre, after the government in late May slapped a special import customs duty on petrol, which is sold at a massive profit by the two fuel retailers in the island.
Lanka IOC imports all its diesel and petrol, while CPC refines half of its products within the country. As a result CPC does not have to pay the duty on all its petrol.
The fuel retailers sell diesel at a subsidised price and try to cover the losses through profits on petrol sales.
The government said after that after the LIOC diesel price hike consumers flocked to CPC retail outlets resulting in increased losses for the state corporation which is already under a heavy debt burden owing to selling subsidised fuel sales.
Ramakrishnan said LIOC has complied with the government request to bring down the price of its diesel to match that of the CPC and now expects the government to reduce the import tax.
The company has asked the government to remove the import tax on petrol.
"We also wrote to the government requesting it to remove the tax and we're hopeful they'll help us out," he said.