Opinion: Demand Destruction for Oil can solve Sri Lanka’s economic crisis

June 13, 2022 (LBO) – Sri Lanka is in the eye of its worst ever economic storm. It appears that with regard to every aspect of the economy, things are coming undone. Whether it be food, fuel, power, tax revenue, foreign reserves, inflation or even law and order, when looked at in aggregate the crisis looks multifaceted and complex.

However, is this really the case? Or is the problem and solution so simple that Sri Lanka’s greatest minds have overlooked it completely? It seems like committees and ministers have been appointed for every aspect of the crisis. Sri Lanka’s best economic minds have even been drafted into a high level economic committee, yet they have not even seemed to put the core of the issue into the public consciousness for debate.

Sri Lanka’s economic crisis is actually an ENERGY crisis, nothing more and nothing less. Energy crises are nothing new to the world. Even the world’s superpower the United States has fought several wars and spent trillions of dollars because of OIL.

So here we stand in Sri Lanka with global oil prices at US$120 a barrel, importing all our petroleum, and still selling derivatives of that imported oil for less than the global price. Sri Lanka will never emerge from this energy/economic crisis if this continues to be the case. When the numbers are tallied, a competent analyst would conclude that it is an impossible situation, yet Sri Lanka is still doing the same thing. There is not even a whimper from Sri Lanka’s intellectual and business elite. Where are the economists, bankers, business chambers? It appears that they have all failed to see the writing on the wall hence we find our economy has been bankrupted in plain view.

The Prime Minister and the Energy Minister have communicated to the public that the monthly fuel bill in Sri Lanka is US$550mn. In reality, for the economy to be in full recovery with no fuel, gas, and energy shortages the monthly bill would be easily over US$600mn. That is US$7.2bn a year. Sri Lanka’s economy is not capable of sustaining this level of fuel imports in its current state. Either we have to reduce the demand for fuel, or markets will eventually destroy our currency and economy.

The Energy Minister has suggested that a quota system is to be implemented for fuel by the end of the month. This is a socialist solution that will be part and parcel of the destruction of the economy. Sri Lanka’s only way out is to increase the retail price of fuel to a level that there is demand destruction. There is a corresponding price of fuel which will reduce Sri Lanka’s import bill by the necessary amount. We need to find that price/demand equilibrium.

In reality we need to reduce annual demand by at least US$2bn, and this likely entails a price increase of at least 50%. This is not all bad news. If a 50% tax on the price of fuel would save US$2bn a year in foreign exchange, it can also provide over US$2bn in tax revenue! These are enormous figures. Keep in mind the Prime Minister has said in a recent speech that he intends to raise just US$500mn in revenue in 2023 from all the new tax increases proposed.

If through a 50% tax on fuel Sri Lanka was able to save US$2bn in foreign exchange, and raise US$2bn in tax revenue in the next 12 months, it is highly likely that an IMF program would quickly follow. Credit markets would start opening up, and Sri Lanka would be well on its way to recovery. There would be an end to shortages, a sharp rebound in tourism, and a stabilisation of the currency causing a sharp increase in remittances.

The tax flows to the exchequer would reduce the need for money printing, providing an anti-inflationary force to counterbalance the inflationary impact of a fuel price rise. Balance of payments improvement would alleviate currency pressures and free up dollars for essential imports. The financial balance sheet of the whole country would soon become much more credit worthy. This in addition to countless other benefits which should be studied and analysed by the powers that be, and compared to the costs (economic and sociological) associated with a sharp fuel price hike.

It is up to the Prime Minister and the President to get together and decide if this is the appropriate way forward. They must be briefed in detail by Sri Lanka’s best minds and both come to a competent understanding of the issue. If they agree on the way forward, a multi-party consensus on this issue must be reached so that all will have political cover. Then it is the duty of politicians to communicate this plan to the public so that they will understand that by suffering through this form of austerity, there will be light at the end of the tunnel.

This crisis can be solved. Sri Lanka is having an energy crisis, which has led to an economic and political crisis. Without solving the core of the issue (energy), we are coming up with complex and convoluted plans to ‘fix’ the economy and change the constitution.

When the President assumed office the price of oil was US$50/barrel. If prices continued to be at that level we would not be in this situation. The key fiscal policy failure of the previous government was not raising fuel prices fast enough to keep pace with the global price increases up to today’s US$120/barrel.

What if prices go to US$200/barrel? Will our policy makers even then properly diagnose the problem and take action? Will our country continue to watch the price of oil like a deer in headlights on the way to meet his maker? Hopefully the stag can come to his senses and make his move before it’s too late.

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14 days ago

This type of tax will only help the rich and penalize the poor!

Parakrama Jayasinghe
13 days ago

This is the right direction. The first step is to refrain from issuing any oil for power generation. There were few days we did manage with zero oil based power. But I see that it is creeping back . Even if this means longer power cuts that is a firm and bold decision to be taken . The damage to the economy and the society is much more due lack of transport fuel than power cuts.

On the same count dollars spent on LPG must be restricted drastically to limit the supplies to essential sections like hospitals. People are already adopting alternatives with out any help from the govt. But some intervention to provide access to the essential minor imports will help accelerate this change over without any cost to the government

Navindra Liyanaarachchi

Article narrowed down Sri Lanka’s current crisis into energy crisis. It is an energy crisis on the top but the root cause isn’t the same. In my view it is much broader in the sense that Sri Lanka’s economic crisis is inherent issue of our bad macroeconomic policies over time. We never had an export oriented economy. Our revenues sources are more primary with less in creating higher margins (exceptions for few). In fact, our consumptions is ever increasing under credit bubble. Only way out of this crisis is to turn economic model into a production and export oriented one. Create value added into our exports and increase margins. Liberalise monetary and fiscal polices that promote business expansions is important.