July 31, 2021

Pressure on the economy continues as fuel price hike comes in at a time that is least opportune.

by Seyeda Mowhiba

The Sri Lankan government announced a sharp increase in the price of fuel last month, prompted by trends of crude oil prices in international markets. This announcement has come at a point in time, when cost of living has risen to become almost unaffordable to many with deteriorating living conditions as a result of the COVID-19 pandemic.

In 2020, retail prices of fuel to consumers were stagnant despite subdued global oil prices. However; the rise in global fuel prices in 2021 was immediately transferred to the consumer to salvage the fiscal position of the country. The price was raised to manage debt pressure of state-owned Ceylon Petroleum Corporation (CPC). This has been on account of the CPC recording losses, with 2020’s bottom line coming in at a loss of LKR 331bn. It has also been done to support balance of payments by lowering import fuel demand which amounts to ~USD 3bn each year, as well as to salvage international reserves of the country which dropped to USD 4bn in May 2021.

The rise in fuel price is expected to lead to increased inflation in the country, driving it to a rate of ~6% in 2021E from 4.2% in 2020. Non-food inflation is expected to account for a majority of this at 71.8% while food inflation would account for ~28.2%. This is mainly due to rising fuel prices having implications across multiple industries. This is not specific to just Sri Lanka, but is a common global phenomenon, given the widespread use of fuel across multiple industries.

The impact of global fuel price hike is further pronounced for Sri Lanka given its weak rupee. A dollar worth of increase per barrel translates to an impact of an upward ~LKR 200 in fuel price. The depreciation of the rupee to this extent is largely owed to extensive foreign currency outflows that have led to the depletion of foreign exchange reserves of the country. The impact on reserves is said to improve after the Central Bank of Sri Lanka ended the suspension of purchasing International Sovereign Bonds (ISB) in the secondary market, conditioning investments to be entirely funded by fresh overseas borrowing. However, again given that the July ISB maturity is expected to be paid out of existing reserves in anticipation of USD 5bn worth of inflows in the second half of this year, timing of inflows for refinancing is key. Should there be a mismatch of inflows, it would only lead to a further depletion of reserves.

An apparent implication of the fuel price hike is on the transportation sector. Freight and logistics costs will certainly rise affecting manufacturers spend on transportation expenses. This only adds to the complexities they have had to encounter amidst import bans and supply constraints due to COVID-19. FMCG manufacturers have widespread distribution networks spanning across the country and have to frequently dispatch products for replenishment at stores to cater to the everyday consumer. Hence transportation cost is a significant component of their overall distribution cost. Rising fuel costs, amidst subdued demand has only worsened levels of pressure to their bottom line which will eventually force them to transfer it to the consumer, again inducing consumer price inflation.

Given that a large number of consumers rely on online purchases and doorstep delivery, costs of their total purchases is also expected to increase owing to increases in delivery charges, reducing frequency of purchase.

On the upside, the government did not increase bus fares following the price hike and promised to offer concessions to private bus owners. Moreover, given that the CPC sells fuel to state owned institutions like Ceylon Electricity Board and Sri Lankan Airlines at subsidized prices, the impact on electricity bills and air fares may not be impacted too adversely.

While such events are only worsening the outlook and mindset of people, we expect the end of lockdowns and resurgence of economic activity to create a positive environment for SMEs in the upcoming months.