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Rising oil prices and the challenges ahead

The current account deficit is set to widen at a faster pace as international oil prices have started recovering after remaining weak for the past eight consecutive quarters. Pakistan is a net oil importer and meets about 75% of needs through imports. Oil imports carry the heaviest weight in total imports of the country. Oil payments, which had been declining for the eight consecutive quarters reversed trend in the second quarter of FY17 and tacked onto an already elevated non-oil bill. The current account deficit in the first eight months (Jul-Feb) 2016-17 has already touched $5.47 billion compared to $2.48 billion in the same period of the previous fiscal year. Analysts say lackluster exports, rising imports and weakening remittances are the major reasons.

Pakistan’s oil consumption from July 2016 to February 2017 jumped 13% year-on-year mainly due to lower petroleum product prices and higher economic activity. Imports of all fuel oil products, particularly high-speed diesel and petrol, have shown significant growth this year, indicating a strong transport sector activity. This has come with a hefty increase in imports of buses and heavy commercial vehicles. Similarly, increase in power generation from furnace oil in 1HFY17 led to higher imports of the fuel.

Pakistan’s trade deficit widens 22%, stands at $9.3 billion. The rise in overall import payments was mainly driven by higher purchases of fuel and capital equipment. This is understandable given that Pakistan is transitioning from a low-growth to higher growth phase, and is addressing supply-side bottlenecks in energy and infrastructure.

In case of exports, the recovery in international cotton prices has yet to translate into higher unit values for Pakistan’s high value-added textile exports. However, on an encouraging note, exports of high value-added textile products, like readymade garments and bed wear, have risen in the first half. This increase has been entirely driven by higher quantum, indicating that these Pakistani products are in demand in key export markets. A stable nominal exchange rate of the rupee versus the US dollar had resulted in appreciation of the Real Effective Exchange Rate (REER), which is hurting exports. Furthermore, lingering uncertainty about the course of US economic policy and the possibility of a protracted global economic weakness, especially in the euro area due to Brexit, could negatively affect exports.

Until the quarter ended September 30, 2016, the savings on oil import payments had been offsetting rising non-oil imports and partially compensating for declining exports. This, coupled with growing remittances (till FY16), had been providing adequate forex reserves cover to the external account and indirectly contributing to reserve accretion. However, this comfort has now started to diminish. A sizable increase in import payments in the first half of FY17, alongside non-receipt of the Coalition Support Fund and a fall in exports and remittances led to a significant widening in the current account deficit.

Pakistan’s import bill may further increase with the surge in oil prices following the supply cut agreement between OPEC and key non-OPEC members in December 2016.

The price of oil is determined essentially by the interplay of demand and supply forces. When demand ratchets up relative to supply, prices go up; when demand ratchets down relative to supply, prices go down. It is not merely the actual demand and supply that shape price – the projected or perceived demand and supply also play a significant role. Thus speculations that oil demand will increase in the wake of, say, the likely acceleration in economic growth in major oil importing countries, will put an upward pressure on oil prices.

The rising oil prices are the major concern for all the developing economies and Pakistan is suffering from it too. Higher oil prices will stoke inflation and put pressure on the balance of payment position and foreign exchange reserves. Since oil is the major source of electricity generation in Pakistan, the hike in petroleum products’ prices may make it difficult to significantly ease power outages. The cost-push inflation caused by the oil price hike ensues from our reliance on oil as major source of energy. We produce 64% of our energy from oil, gas and coal based operations. Besides increasing domestic oil output, we will have to gradually do away with the use of oil for power generation. Use of oil by the transport sector should also be minimized by adapting to CNG based transport system. Modern mass transit projects also need to be designed and completed on an emergency basis. This will not only minimize the use of private transport but will also improve the fast deteriorating traffic situation throughout the country.

An increase in oil price leads to inflation, increase budget deficit and puts downward pressure on exchange rate, which makes imports more expensive. The increase in oil price has further effect on the daily consumption pattern of households. However, a lower government spending, a higher real stock price and a lower interest rate would raise real output for Pakistan. The antidote to the sky rocketing oil prices is a concerted effort to achieve major breakthrough in the areas of gas exploration, enhanced hydro power generation and coal-based energy production.

The silver lining is that increased oil prices will push up economic growth in Gulf countries, which are a major source of remittances for Pakistan. Needless to say, the remittances are one factor that has sustained the economy over past several years.

Pakistan’s growth prospects continue to improve if inflation remains contained. However, weak fiscal performance and pressures in the external account pose a challenge. Efforts to reverse the current imbalances and continued implementation of structural reforms would be needed for sustaining and accelerating growth and improving welfare.

The writer is a Karachi based freelance columnist and is a banker by profession. He could be reached on Twitter @ReluctantAhsan

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