Temporary fuel subsidy risks undermining fiscal buffers

• HNB Stockbrokers says three-month fuel subsidy estimated to cost around Rs. 57 b
• Cautions extended support could exceed Rs. 150 b this year
• Subsidy seen conflicting with IMF cost-recovery pricing commitments
• Concerns raised over lack of targeting despite pressure from oil shock

HNB Stockbrokers has warned that Sri Lanka’s recently announced fuel subsidy, while manageable in the short term, risks eroding fiscal buffers and complicating commitments under the International Monetary Fund (IMF) program if extended beyond its initial three-month period.

In a series of posts published on ‘X,’ the brokerage described the subsidy as a response to the oil price shock triggered by the escalating conflict in the Middle East, but cautioned that the larger risk lay not in immediate affordability but in the possibility of the measure becoming permanent.

The Government recently announced a three-month fuel subsidy providing Rs. 100 per litre on diesel and Rs. 20 per litre on petrol. HNB Stockbrokers estimated the package would cost approximately Rs. 57 billion over the initial period.

The brokerage noted that, at first glance, the subsidy appeared fiscally manageable given the Government’s stronger-than-expected fiscal position this year.

Sri Lanka recorded a primary surplus of approximately Rs. 545.5 billion during the first two months of 2026, already exceeding the full-year target of around Rs. 360 billion, according to HNB Stockbrokers.

However, the brokerage warned that the fiscal cost could escalate significantly if the subsidy were extended beyond the initial period.

“At roughly Rs. 19 billion per month, extending the subsidy to year-end could cost around Rs. 150 billion at current oil prices and exchange rates,” the brokerage said, adding that the cost could exceed Rs. 200 billion if crude oil prices increased further or the rupee weakened.

HNB Stockbrokers argued that while a temporary subsidy could be absorbed within existing fiscal space, a prolonged subsidy regime would steadily weaken the Government’s fiscal cushion at a time when Sri Lanka remains under an IMF-supported stabilisation program.

The brokerage also highlighted the tension between the subsidy and Sri Lanka’s IMF commitments on cost-reflective energy pricing.

Under the IMF program, restoring cost-recovery pricing for fuel and electricity while protecting vulnerable groups remains one of the prior actions linked to completion of the combined Fifth and Sixth Reviews under the Extended Fund Facility (EFF).

HNB Stockbrokers noted that subsidised diesel prices currently stood significantly below estimated market cost levels, describing this as inconsistent with the principle of cost-reflective pricing embedded within the IMF framework.

The brokerage further argued that while the subsidy was both time-bound and costed, it failed to align with the IMF’s preference for targeted relief measures aimed specifically at vulnerable groups. 

“The IMF’s test for shock support is clear: well-targeted, carefully costed, and time-bound,” HNB Stockbrokers said.

It noted that a flat per-litre subsidy benefitting all motorists did not directly target lower-income households most affected by rising living costs.

The brokerage also referred to comments made by IMF Communications Director Julie Kozack during a media briefing on 14 May, where she avoided directly addressing whether the diesel subsidy was consistent with IMF cost-recovery commitments or whether it could affect approval of the next tranche under the program.

Instead, Kozack reiterated the importance of restoring cost-reflective pricing mechanisms, highlighted Sri Lanka’s strong economic performance in 2025, and said the IMF Executive Board was expected to consider Sri Lanka’s combined Fifth and Sixth Reviews in the coming weeks.