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Trying times for Pakistan in the context of oil prices increase

Some of the analysts at the recently held FT Commodities Global Summit said they expect oil prices to hover between $60 and $70 in the foreseeable future. For an oil-importing country like Pakistan that can hardly contain its current account deficit despite record-low energy prices, a rise in Brent crude can possibly be an indicator of tough times to come.

Two of the major areas where the impact of rising oil prices will be felt are remittances and inflation measured by the Consumer Price Index (CPI). An increase in global oil prices will increase the rate of inflation in Pakistan that has remained gloomy since October 2014.

Growth in remittances has slowed down in the current fiscal year. Many experts attribute to reduced global oil prices causing a cut in public spending in the oil-rich Arab countries. After all, the share of remittances from the oil-rich Gulf nations in Pakistan’s remittances is almost 65 percent.

According to a recent research conducted by the State Bank of Pakistan (SBP) these assumptions may not be hundred correct. The slowdown in remittances growth was expected in view of the fiscal constraints in the Gulf region, the SBP said it was “still higher compared with other countries.”

Despite record-low oil prices, the number of Pakistani workers going to the Gulf countries has risen in recent months. As many as 946,571 Pakistanis went abroad in July-Dec 2015, which translates into a growth rate of 25.8 percent over the same period of 2014. In fact, the number of Pakistani workers going to Saudi Arabia, Qatar and Oman increased 67 percent, 26.9 percent and 20.1percent respectively, over the same period.

The impact of falling oil prices is yet to translate into lower labour demand from the Gulf Cooperation Council (GCC) via reduced spending on infrastructure and transport.

As for the assumption that falling international oil prices is the only reason for low inflation in Pakistan. It is noted that inflation had started declining back in December 2013 although the slump in oil prices began only in July 2014. The fall in oil prices was one of the major factors behind the recent decline in inflation, other factors such as lower commodity prices (wheat, rice and edible oil) also contributed to the softening of CPI inflation.

It is too early to say how much the rising oil prices will affect inflation and remittances growth. The forecasts about oil prices have been not right in the past.

A large number of experts and economists predicted global oil prices would go down as low as $10 a barrel; Brent crude has made a rebound by hitting the highest level since the beginning of 2016.

Pakistan has failed to push through economic reforms, raising the likelihood of economic turmoil in the midst of global economic headwinds.

Increased interest rates in the US, strengthening dollar, and rising oil prices will drive the turbulence faced by emerging and frontier economies.

The expected interest rate hike in the US will draw liquidity away from emerging market debt, having a negative impact on countries that rely on the international bond market to meet their external financing needs.

Rising oil prices in the wake of the deal between the Organization of the Petroleum Exporting Countries (OPEC) and non-OPEC countries will increase the import bill for oil-importing economies, leading to inflationary pressures and a greater need of foreign currency to pay for oil imports.

A strengthening dollar will boost exports for competitive economies, but oil-importing countries will face increased pressures on their foreign currency reserves.

Pakistan has indulged on cheap dollar debt to raise over $35 billion in external debt since 2013. Oil prices, which fell to under $50 a barrel from over $100, brought about annual savings of over $7bn during this period.

A stable rupee allowed the country to import greater amounts of capital goods required for generating power and building public infrastructure.

The increased spending on infrastructure, rising foreign currency reserves, and benefits of the IMF programme restored stability and brought about a rise in GDP growth.

The US dollar has been on a tear since the Nov 8 presidential elections in the US. The Turkish lira has been the worst hit, losing over 10 per cent against the greenback since the elections. The Mexican peso, Brazilian real, Malaysian ringgit, and the Indian rupee are among a whole host of currencies that have also lost value during this period.

The Pakistani rupee has also depreciated with the exchange rate of the dollar crossing Rs109 in recent days, causing dollar shortages in the open market.

On Nov 30, OPEC members agreed to reduce output by 1.2 million barrels a day in the first production cuts in over eight years. Non-OPEC members joined in on Dec 10, with Russia leading the way in cutting 300,000 barrels out of a total 528,000 barrels a day cut.

Oil prices have sharply rebounded and crossed the $56 a barrel mark following these agreements. Following the 1.8 million barrels a day cut, experts have updated their price forecasts and now expect the price of oil to hover closer to the $70 a barrel in 2017.

Higher oil prices will increase Pakistan’s import bill and increased petroleum prices will intensify inflationary pressures. The rupee, which is already under pressure, will face further depreciation in the market as Pakistan reckons with both a resurgent dollar and rising import bill.

Under such a scenario the State Bank would have to dip into its foreign currency reserves to stabilize the rupee and pay for oil imports.

The current government has allowed an appreciation in the real exchange rate of the rupee .The IMF has raised this issue in numerous reports about the state of the economy.

An unintended consequence of this policy has been deterioration in export competitiveness as other emerging economies have allowed their currencies to depreciate in the international market.

The depreciation of the rupee could restore some competitiveness to Pakistan’s exports. However, this positive impact would not be as extensive due to the fact that Pakistan’s exports suffer from a general lack of competitiveness and that other currencies have and are depreciating.

Recovering finances in the Gulf could raise remittance inflows into Pakistan. These inflows have been stagnant in recent months as economic activity in oil-exporting economies of the Gulf has slowed down.

The rebound, however, could take months as countries such as Saudi Arabia rebuild their balance sheets after years of low oil prices.

In the coming years Pakistan will also face rising external financing needs. These cannot be met by the current inflow of dollars from exports and remittances.

According to IMF data, the country will require over $13 billion a year from 2017 to 2020. This estimate does not take into account the depletion of foreign currency reserves that could occur under the scenario highlighted above.

Taking this fact into a reality, we can expect that Pakistan will struggle to meet its external financing needs and could find itself back in the arms of the IMF.

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