Market-linked fuel pricing accelerates inflation pass-through as oil surges: IPS study

Sri Lanka’s shift to a market-linked fuel pricing mechanism has fundamentally altered how global oil shocks feed into domestic inflation, with the latest surge in crude prices expected to transmit more rapidly and broadly across the economy, a new analysis by the Institute of Policy Studies (IPS) shows.

Crude oil prices have climbed sharply from around US$ 65 per barrel before the onset of the current conflict to about US$ 102, a 59 percent increase, raising fresh concerns over inflationary pressures in an economy still navigating post-crisis recovery.

According to IPS Research Fellow Dr. Pulasthi Amarasinghe, the impact of such shocks is now markedly different from the pre-2022 period, when fuel prices were largely administered and adjusted irregularly. Under that regime, global oil price increases had only a muted and delayed effect on the Consumer Price Index (CPI).

“In contrast, the current market-linked pricing system allows global energy price movements to pass through more directly into domestic inflation,” the study notes, with CPI responding more significantly within months of a shock.

The change, while exposing consumers more immediately to price increases, reflects a broader structural correction. Suppressing fuel price adjustments in the past masked underlying costs, which later surfaced as fiscal strain and external imbalances, pressures that culminated during the 2022 economic crisis.

The sectoral transmission of oil shocks is uneven but sequential. Transport prices react first and most sharply, as higher fuel costs are quickly passed on to commuters and logistics providers. This initial spike then cascades into food prices, driven largely by higher distribution and supply chain costs in an economy heavily reliant on road transport.

Food inflation remains a key concern, particularly given its weight in household expenditure and lingering food security challenges among lower-income groups. The study warns that additional risks, such as fertiliser constraints or global export restrictions, could further intensify price pressures. Non-food items, including manufactured goods and services, tend to adjust more gradually, reflecting second-round effects as businesses pass on higher operating costs. Meanwhile, utilities such as electricity and LPG exhibit delayed adjustments due to periodic tariff revisions, creating a lag before full price impacts are felt.

The IPS analysis asserts that with market-linked pricing now entrenched, the focus of policy must shift from suppressing price movements to managing their transmission. Ensuring efficient supply chains, maintaining transparent pricing, and safeguarding access to key inputs such as fuel and fertiliser will be critical in containing the broader economic fallout.