DISCORD IN DOMESTIC & INTERNATIONAL OIL PRICES

SAAD ANWAR HASHMI
(feedback@pgeconomist.com)

Oct 1 - 7, 20
12

The domestic oil prices have been revised frequently at times on a weekly basis rather than monthly, each time with an upward revision in price rather than giving the economy relief with lower oil prices to help reduce inflationary pressures. Each time the government would announce an increase in oil price, reasons cited are international oil prices impacting domestic prices. Looking at the global environment, the oil prices have been volatile currently trading at USD 90 per barrel and expected to either remain at current levels or increase further. The tax base is poor since the government does not have the mechanism to collect taxes as large part of the economy is undocumented and mostly unbanked. Pakistan is in a situation where in addition to lower tax base exports are half of that of imports. To finance the expenditure, the government has resorted to either borrowing from World Bank or Asian Development Bank being international advances denominated in US Dollars along with borrowing from the banking system.

The government uses the oil prices as a major component to receive tax and cannot seem to find a substitute to oil for collecting taxes in order to meet budgetary deficits. Borrowing from the banking system increases inflation where CPI as on July 2012 stood at 9.60 percent with electricity, fuel and gas accounting for 29.41% of the CPI. A source for liquidity pressures in the economy is sluggish economic growth and foreign direct investments which could substitute low tax base. SBP stressed that the government must devise fiscal and energy sector reforms and plan foreign financial inflows to mitigate uncertainty and pressure on reserves. In order to meet budgetary deficits, the government seems to revise the oil price independent of the price in the international markets. No matter what the price in the international markets maybe, the oil price for domestic consumption is defined on a number of factors which seems to have little to do with international prices.

With tax collection involved, the higher the domestic price for oil, the higher the tax collection for the government. International oil prices hover around USD 90 per barrel where each barrel carries 119.24 liters. Translating into PAK Rupees, each barrel based on international oil prices today cost approximately PKR 71.0 whereas the domestic price of Premium petroleum is PKR 108.45, a difference if more than PKR 37 per litter in taxes which computes to almost 33 percent to 35 percent in tax for each liter of fuel sold in the market. Considering this basic calculation, petroleum can easily be sold for PKR 70 to PKR 71 per liter if the government follows the exact mechanism of international oil prices and pass on the effect to the consumers. This further means that the domestic oil prices in Pakistan are less correlated with international oil prices and has more to do with the government making an attempt to finance the budgetary deficits.

If oil prices are used as a cushion for budgetary support it seems difficult to acknowledge how the government hopes to maintain the budget deficit to less than 5 percent of GDP with tax collection target of PKR 2.38 trillion through FY13.

The challenge for SBP with the Monetary Policy is to reduce inflation and encourage private sector lending alongside an attractive rate of return for depositors to counter rise in inflation. The Monetary Policy cannot work in isolation considering external shocks e.g. international oil prices, recessionary impact, devaluation in interest rates or government borrowings. It is however an encouraging sign that SBP wants to increase off take of advances through the banking channel through reduction in the Policy Rate. It is yet to be seen if advances, particularly in the Consumer Sector including Credit Cards, Home Loans, Auto Loans and Mortgages do actually increase. Pakistan is a net importer therefore any devaluation in the exchange rate against the dollar will make imports expensive and put further pressure on the reserves. Though exports due to such devaluation are expected to grow, however considering rise in input cost, such differential may be negated making prices unattractive for the export markets. Rising oil prices impacts commodities and raw materials across the board and fuels inflation. Since there is no price control mechanism in Pakistan , a 5 percent increase in oil price domestically as a hypothetical example would increase commodity prices by more than 5 percent acting as a catalyst to inflation.

Estimating the future price of oil remains a challenge for industry experts resulting in variation of views on future oil movements resulting in high degree of speculation and upward trades in the Futures commodity markets. The decisions taken by OPEC eventually effect the decisions taken by the Oil and Gas Regulatory Authority (OGRA) in Pakistan . Taxing oil for the government is considered the easiest option to finance the budgetary constraints. The government time after time has announced incase in price in line with international oil prices and has also announced increases when the international oil prices were on a decline. The government has also pushed OGRA to increase the price of oil independent of either inflation or international oil prices in order to earn additional revenue to finance its expenditures and deficits.

For a country like Pakistan , rising oil import bill through increase in international oil prices coupled with devaluation of Rupees against the Dollar has kept the domestic oil price high with a consistent upward trend. The result of such increase has caused various demonstrations for control of inflation surging from the supplyside. Inflation which is liked to price of oil due to international oil prices cannot be controlled in the short run unless the government substitutes the tax base on oil with another commodity which seems unlikely. Those avoiding the price hike on oil with conversion to CNG have faced tougher challenges with gas shortages and closure of CNG stations. OGRAs decision to pass on the price increase to the buyers is under question. Tax base on oil can be removed provided the government finds alternatives to earn taxable income other than oil and increase its tax base. The long run impact on oil price in Pakistan will continue to depend on the international oil prices driven through capacity of the government to meet budgetary deficits.