Increase in oil prices may add to inflationary pressure

Dec 03 - 09, 2007

Pakistan's oil import bill is likely to rise to 5.5% of GDP i.e., US$9.0billion in the face of price level at US$75/bbl), vs. US$7.4billion (5.0% of GDP) last year.

It is interesting to note that the adverse impact of high oil prices have not been realized yet at large in the country owing to stagnant domestic oil prices and higher subsidies borne by the government so far. The differential of international prices was not passed on to the consumers by the government obviously due to political reasons as the unpopular decision to increase in oil prices could lead to a hue and cry in the masses. However, things may not be the same any more as the government has no option to pass on the differential one of these days.

Given the sustained rise in international oil prices, the government may also raise domestic oil prices which consequently affect transportation cost, electricity and gas tariffs.

Resultantly, the Current Account (C/A) deficit of US$7.7billion would naturally widen further at US$65/bbl WTI oil price in the financial year 2008 for Pakistan. It is interesting to note that every 10% rise in oil prices adds US$700million to the import bill and the C/A deficit. So, the oil import bill and C/A deficit to rise by another US$1.4billion, if average oil price assumption raised to US$75/bbl for the full financial year 2008. During the financial year 2008 investments is US$5.1billion as against. US$8.4billion in the financial year 2007.

At this point of time, the obvious question is whether Pakistan's credit rating could be hurt if it accumulates another US$4 billion in external debts. Pakistan however can easily raise US$4billion while keeping the external debt-to-GDP ratio constant at 27.5% in FY08E or US$44billion, vs. the current debt level of US$40billion. This should help to maintain credit rating of the country.

Credit however goes to the economic strength of the country achieved on the back of strong policies and decision which is reflected in the fact that despite political uncertainty which entailed various political shocks since October last, Pakistan has attracted US$990million in foreign flows during first quarter of 2008. This figure is expected to rise by US$400-500million, as equity market alone has added US$250millionn in October and US$72million in the first 10 days of November.

On the external front, two global leaders, Hong Kong-based Hutchison Whampoa, and UAE-based International Petroleum Investment Co, have recently inked multi-billion dollar agreements for the development of a deep water container terminal and the largest refinery in Pakistan respectively indicating the global players' increasing confidence on the Pakistan economy. It is expected that foreign flows and the privatization process to be revived once the new government starts operations from January 2008 onwards.


The most distributing factor in the wake of increase in oil prices is feared to add to the inflation pressures which were recorded at 9.31 percent and 8.37 percent in October and September respectively. Despite the fact that the government is absorbing increase and subsidizing heavily to the tune of Rs13 billion every month, sources told to PAGE, however accumulated losses have reached a point where the government is bound to go for increase in oil prices in December indicated by the government sources.

Though it does not look nice to refer to prevailing inflationary level in the energy starved India where it is below 4 percent as against 8-9 percent in Pakistan obviously due to a yawning gap between living styles of the ruling community in the two countries.

A rough estimate suggest that 10% increase in domestic inflation would add 1.5% to Consumer Price Index (CPI) over and above Inline with the rest of the world, Pakistan inflation is grappled with higher food prices.

As per Federal Bureau of Statistics (FBS), Pakistan CPI inflation for October came in at 9.31% (up from 8.37% in September). Food inflation (comprising 40.32% of CPI), came in at 14.7% YoY (up from 13% in September), while Housing Rent Index (HRI) also continues its upward march and came in at 7.8% (from 7.5% last month).

Actually, despite all economic successes the economic managers seem helpless to control inflation since FY05, due to extremely volatile food & international oil prices and overheating economy. So far food inflation is dominating the inflation scene, which is expected to be taken over by oil prices. Recently, the caretaker Finance minister has tipped for higher oil, gas and power prices, to avoid huge subsidies and pressure on current expenditures.

It may be mentioned that core inflation as per our estimates for the month of October was recorded at 5.77% (up from 5.4% YoY last month), primarily driven by higher HRI and apparel. The risk of pronounced second round of inflation is very much on the cards due to the permanent rise in food and oil inflation off late. This can also be validated from State Bank of Pakistan's inflation monitor for the month of September 2007.

The wage inflation for the month of September 2007 however came in at 14.2%, marginally lower than 14.5% of September 2006. At the same time, pressure on underlying inflation is on the rise at 6.5% YoY in October, compared to 5.2% in May 2007, inline with the increase in 20% trimmed mean inflation to counter the impact of higher inflation; SBP has done its home work by tightening and rendering tight liquidity conditions.

The central banks however has managed to control reserve money growth at 4.07% YTD (down from 11.81% last year), which in turn is likely to keep money supply under check. This has also reflected in the substantial slowdown in private credit growth, highlighting little need of interest rate hikes. Despite all this home work, financial analysts feel that inflationary respite is yet to emerge, indicating the room for administrative/ bureaucratic policy improvement.

To prevent the severity of second round of inflation, the central banks is likely to continue to maintain its strong stance against inflation and keep liquidity conditions tight in the days to come.