The Organisation of Petroleum Exporting Countries’ (OPEC) recent agreement to cut production by 1.2 million barrels a day starting January spells a disaster for oil-importing economies like Pakistan. Non-members, including Russia, have also agreed to pitch in by reducing output by a combined 558,000 barrels a day — to formalise the cooperation, a deal was struck between OPEC and other oil-producing countries, outside the OPEC, to bring down supply.
While it may still be debated whether cutting production will prove to be an effective strategy to balance an oversupplied market, the move could simply push the US towards increasing production — according to the International Energy Agency’s monthly oil report, if OPEC members and non-OPEC countries stick to their pledge to cut production for the next six months, the market likely will become undersupplied by the first half of next year.
Together with the news of the planned production cut, the willingness of non-OPEC producers to join the cutbacks is driving oil prices upwards. This puts a country like Pakistan in a precarious situation. Having to meet 80 per cent of its oil requirements through import, Pakistan’s economy is vulnerable to turmoil in the oil market — the impact of bullish oil prices on the economy is going to be devastating to say the least.
“Due to the trend of low oil prices, our balance of payments position remained somewhat more stable than it would have been otherwise. Now, the problem is that the price is increasing and it has already crossed $50 a barrel (which already represents an increase of $10 a barrel for us). For every $10 a barrel, the additional cost is just over $1 billion so that is one thing that is affecting our balance of payments at a time when our exports are not doing too well and imports continue to rise, particularly since we’re importing power-generating machinery in a big way. So, the outcome is that the rise in oil prices is going to put pressure on our balance of payments,” says economist Dr Hafeez Pasha.
“I hope the price of crude oil remains at $50 but the projection is that by the end of this financial year in June, the price could approach $60,” he adds.
“Instead of reducing oil prices from about Rs100 to Rs70, the government should have retained the price at Rs100, created a revenue surplus out of that and reduced GST on manufacturing. That would have helped boost industry as well as exports and create jobs.”
This likely reality, he points out, paints a grim picture for Pakistan’s oil-heavy import bill. “Yet another increase of $10 per barrel means yet another $1 billion is added to import bill,” he explains.
Pakistan’s dwindling foreign reserves have added to its economic woes which, in the last one month, have fallen by a whopping $800 million.
“It is for the first time since the IMF programme started that our reserves have fallen by such a significant amount and that too in just one month which is a cause for concern,” agrees Dr Pasha.
Reflecting on the government’s apparent reluctance to pass on the impact of rising oil prices to consumers, he says, “So far, the government has not transferred the impact of increasing oil prices on to the consumers, except for an increase of about 2 to 3 per cent in December. But they have tried to absorb the price increase by reducing the sales tax rates. The result has been that our revenues have been affected adversely.”
“The situation is such that the total tax revenue growth in the first three months is 2 per cent and non-tax revenues have plummeted by 48 per cent. The end result is that overall revenues have declined by 8 per cent. It is for the first time in the last 5 to 6 years that revenues are actually declining. So this is all very worrying. If the government, given the political situation, decides that it wants to absorb as much as it can without increasing taxes then the fiscal deficit increases further,” he states.
This decision comes at a cost. “Much of the fiscal deficit is being financed for the first time after the IMF programme by borrowing from the State Bank of Pakistan. It is incredible that we have already borrowed over a trillion rupees from the State Bank. This is completely unprecedented over the last few years. This has been done because they are under no pressure from the IMF not to borrow from the central bank because that tends to have an impact on the reserve money and also has a really big impact on the inflation rate,” Pasha points out.
He expects the inflation rate to approach a high single-digit by June 2017. With respect to the rising oil prices right now and the possible course of action of the government, he outlines two options: “transferring the increase into taxes to raise more revenue as the prices rise and stabilise our revenue position which will lead to cost-push inflation” or “if the government decides to absorb the price increase, the revenues will suffer and we will borrow from the State Bank and we will have demand-pull inflationary pressure.”
Elaborating the impact of a revamped energy portfolio — one that seeks to lessen the country’s dependence on oil for power generation — he says, “The new power projects that will come into operation in late 2017 and early 2018, most of them are based on coal and LNG. The prices of both are rising and part of this trend is linked with oil and for an additional 5000MW (which is what we plan to generate in 2017), the cost of coal imports and LNG is both about $2-$3 billion.”
Economist Dr Kaiser Bengali sheds light on the ideal way that the ‘golden days’ of oil surplus and low prices should have been dealt with by the government.
“Instead of reducing oil prices from about Rs100 to Rs70, the government should have retained the price at Rs100, created a revenue surplus out of that and reduced GST on manufacturing. That would have helped boost industry as well as exports and create jobs. Instead, the government has enjoyed the lower balance of payments deficit which it would have enjoyed any way if it would have not reduced domestic prices. The consumers would not have burnt away gas in their vehicles (which is also harmful for the environment) and would have had a stronger manufacturing sector and a stronger job market. While the bonanza lasted, we could have invested in our industry — a more long-term sustainable benefit for everyone, including the government as with more manufacturing, you can generate more in tax revenue,” he says.
He points out that the government has a very comfortable majority and decisions related to economic policy should reflect the same confidence. “It didn’t have the spine to take a very strong stand in the past but it enjoys a comfortable majority,” he says. Once again, as an elaborate game of chess is played out in the international oil market, post-IMF Pakistan’s prudence will be put to test.