IMF urges Sri Lanka to let fuel prices rise with global markets as risks mount

The International Monetary Fund has urged Sri Lanka to allow domestic fuel prices to move with international prices and maintain cost-recovery energy pricing as the country faces renewed economic risks from the prolonged war in the Middle East, global trade uncertainty and the potential effects of El Niño.

The call came as the IMF and Sri Lankan authorities reached a staff-level agreement on the seventh review of the country’s four-year Extended Fund Facility program. The agreement is subject to approval by the IMF Executive Board.

“In response to a protracted Middle East war, the government should allow domestic fuel prices to adjust in line with international fuel price movements and preserve cost-recovery energy pricing, while protecting the vulnerable,” IMF Mission Chief for Sri Lanka Evan Papageorgiou said in a statement.

The IMF said Sri Lanka’s economy has remained resilient, but warned that sustaining the recovery will require continued fiscal discipline and reforms as external shocks threaten to put pressure on inflation, public finances and foreign exchange reserves.

The Fund said the government should avoid broad or open-ended measures to shield consumers from higher energy costs if the Middle East conflict pushes international fuel prices higher.

Instead, support should be targeted at vulnerable households, kept within the budget, carefully costed and limited in duration, the IMF said. Poverty-targeted cash transfers should be used to protect those most affected.

The warning reflects a key tension for Sri Lanka as it seeks to preserve the gains made under its IMF-backed reform program: shielding consumers from higher fuel prices could ease the immediate impact on households, but prolonged price controls or subsidies could put pressure on government finances and undermine the country’s fiscal and debt sustainability.

The IMF also warned that a prolonged Middle East war could generate broader inflationary pressures. If those pressures become stronger and inflation expectations begin to move away from the central bank’s target, monetary policy should be prepared to tighten, it said.

Sri Lanka also faces risks from global trade policy and El Niño, according to the Fund.

Despite those risks, the IMF said recent economic indicators remained positive. The economy expanded 4.2% year over year in the second quarter of 2026, marking 11 consecutive quarters of growth. Headline inflation was 8% year over year in September, while gross official reserves reached $6.9 billion at the end of August.

The country’s banks remained well capitalized and profitable, while fiscal performance during the first half of 2026 was strong, the IMF said. Debt restructuring was also largely completed.

The Fund said maintaining those gains would depend on Sri Lanka staying on its broader reform path.

It called for the development of a medium-term revenue strategy to strengthen government revenue while improving the efficiency and fairness of the tax system. The IMF also urged continued improvements in public investment management, including measures to accelerate recovery and reconstruction following Cyclone Ditwah.

““Greater exchange rate flexibility remains key to absorbing shocks and supporting reserve accumulation,” the Fund said.

The IMF also stressed the importance of maintaining the country’s anti-corruption legislative framework and pursuing structural reforms to support longer-term growth. These include liberalizing trade, modernizing business and labor regulations, expanding access to finance, improving digital public infrastructure and addressing infrastructure gaps.

The latest IMF agreement would give Sri Lanka access to SDR 254 million, or about $345 million, if the Executive Board approves the review. That would bring total IMF disbursements under the current program to SDR 2.032 billion, or about $2.7 billion.

Board approval is contingent on Sri Lanka’s finance minister presenting the 2027 budget to Parliament in line with IMF program parameters and the completion of a financing assurances review covering multilateral financing contributions and progress on debt restructuring.

The IMF mission visited Sri Lanka from Sept. 10-23 before holding virtual discussions with senior Sri Lankan officials to finalize the staff-level agreement. (Newswire)

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