With the cost of living crisis pushing many people over the edge and the struggles experienced by many families likely to worsen, the recent increase in fuel prices by the Government is primed to add to the burden.
Official figures published for July showed that headline inflation as measured by the Year-on-Year (YoY) change in the National Consumer Price Index was 4.6%. Despite food inflation showing at -2.5% and non-food inflation decreasing to 10.9% in July, reportedly due to decreases in food items as well as decreases in prices of water, electricity, gas, and other fuels (electricity bill and LP Gas) among others, finances of ordinary citizens continue to come under growing pressure.
As part of its latest round of fuel price revisions, with effect from midnight of 31 August, the Ceylon Petroleum Corporation (CPC) increased fuel prices. Accordingly, the price of octane 92 petrol was increased by Rs. 13 to Rs. 361 per litre, octane 95 petrol by Rs. 42 to Rs. 417, auto diesel by Rs. 35 to Rs. 341, super diesel by Rs. 1 to Rs. 359, and kerosene by Rs. 5 to Rs. 231.
Given the backdrop of a struggling populace despite a much-touted drop in inflation, The Sunday Morning spoke to several economists on the impact of this fuel price hike for the ordinary citizen.
Economic relationship between fuel prices and inflation
According to economists, fuel prices and inflation have a strong positive relationship in economic terms.
Speaking to The Sunday Morning, University of Peradeniya Department of Economics and Statistics Prof. O.G. Dayaratna-Banda said: “Normally, when energy prices increase, it should cause an increase in inflation. However, it depends on what happens to prices of other goods included in the market basket of the price index. For instance, in a scenario where other prices do not increase while fuel prices increase, then fuel prices will not have a significant impact on inflation. Theoretically, however, there is a positive impact on inflation through cost.”
Meanwhile, University of Peradeniya Department of Economics and Statistics Prof. Wasantha Athukorala explained the relationship between fuel and inflation as “strongly correlated,” adding: “There is some evidence to say that there is a strong negative relationship between fuel prices and economic growth in the country. When fuel prices increase, it contributes to decreasing a country’s economic growth.”
Impact on currently easing inflation
According to Prof. Dayaratna-Banda, the fuel price increase is unlikely to have a significant impact on the disinflation process.
He said: “Inflation is calculated by a price index which includes various goods and services, not only fuel. Therefore, whether the fuel price increase will drive up inflation depends on what happens to prices of other products and services included in the basket.
“When considering overall inflation data, I don’t think it will have a significant impact on the disinflation process. While it will have some impact since the basket that is used to compute the price index uses many other products, what will happen is that the disinflation speed may slow down.”
Pointing out that disinflation had been taking place from about August-September 2022 to now, he emphasised that disinflation did not mean a reduction of prices, but rather a drop in the rate of increase of prices. “At present, prices of products have not dropped, but the rate of increase of prices has dropped, meaning average prices of products are still increasing.”
According to Prof. Dayaratna-Banda, while the Central Bank’s target of 5.4% inflation could be delayed as a result of the fuel price increase, it is unlikely to lead to rising inflation.
Adding to cost of living burden
Prof. Athukorala meanwhile noted that the inflation statistics did not reveal ground realities, since no relief was being felt by the public in terms of the cost of living.
“Last September was the peak of inflation in Sri Lanka; for this year’s inflation, we are comparing with the peak of last year. Therefore, in calculating inflation, we will not see a high rate since we are comparing with last year. The Government could thus argue that inflation is decreasing, but the reality is different; the cost of living is increasing daily,” he said.
Moreover, he pointed out that while the fuel price increase could impact the prices of some commodity prices in the market basket used to calculate the price index, it would not lead to abrupt spikes in prices like the previous year. However, he opined that it would have some impact on increasing inflation.
According to Prof. Athukorala, the impact of the fuel price revision would depend on the influence it would have on goods and services.
“Here, the magnitude of the correlation is the most important. Since we are presently at a higher inflation level, a change in fuel prices will drive up prices and we will face some kind of inflation. Ultimately, what is important is how this will affect the country’s economy; this will have some negative impacts on the entire economy. We had negative economic growth in the first quarter of this year and very high negative growth in the second quarter. Given this backdrop, the fuel price changes will have a negative impact on the entire economy.
“Over the past year, the Government increased not only the fuel prices but also the prices of electricity, water, etc. As a result, prices of almost all commodities increased rapidly. This is what is defined as high inflation,” he said, adding that the Government had done this with no understanding of the problems plaguing the CPC or the Ceylon Electricity Board (CEB), which he termed as “highly inefficient institutions”.
“We need to make these institutions more efficient – this would have enabled a reduction in prices. However, instead of focusing on this, the Government is attempting to cover the loss by increasing prices. At the moment, the Government is trying to benefit by imposing big taxes on these products. For instance, we are paying very high prices for fuel in this country, but if you look at global prices of fuel, there has not been a significant increase. Ultimately, this will undoubtedly lead to increased inflation.”
Direct costs for transport, industry
Addressing the direct impact of the fuel price hike on the public, which in turn will impact transport costs, Prof. Athukorala said: “Ordinary people are affected in two ways: firstly when fuel prices increase, their personal transport costs will increase directly. In a recent study which calculated how much of income is spent on transport, we found that some middle class people spent 20-40% of their income as transport expenditure. This is a very high amount. This component of the cost will rise due to the fuel price increase.
“Secondly, the commodity prices will be affected; since commodities are transported using lorries etc. When fuel prices increase, the cost of commodity transport will increase, causing this cost to be added to the commodities.”
Prof. Dayaratna-Banda noted that the impact of the diesel price hike would be most strongly felt in terms of the economy.
“Diesel is used for transportation and for operating machinery. Therefore, diesel prices ordinarily lead to cost increases. As a result of increased diesel prices, not only transportation costs but even production costs can sometimes increase. Moreover, diesel is used for electricity generation. In this sense, diesel price increases ordinarily contribute directly to cost increases, which may contribute to inflation.”
However, he opined that since the diesel price increase was not significant, it would depend on whether producers or transporters would raise their prices. “I don’t think they would increase their prices because this is a minor increase,” he observed.
Prof. Dayaratna-Banda noted that since diesel was a key input in the economy, any impact on diesel prices would be significant. “For an impact on inflation, the primary factor is whether costs will increase – costs of production, transportation, distribution – since diesel is linked to this. For petrol, however, since it is used for personal automobiles, the costs faced by citizens will increase.”
Addressing the diesel prices, Prof. Athukorala also remarked that the negligible increase of Rs. 1 for super diesel signified ulterior motives by the Government.
“Super diesel is used by politicians since their vehicles are diesel jeeps which run on super diesel. Even kerosene prices have been increased, unlike super diesel.”
As millions of families continue to face mounting hardship, the new pressures will undoubtedly add to their economic woes.