Desperate times

Just as a glimmer of hope appeared of life getting back to normalcy after economic shock of pandemic, the war between Russia and Ukraine has created a new wave of uncertainty. Commodity prices — which were already at multi-years hike — are further escalating. This is putting immense pressure on economic sustainability of economies, including Pakistan’s, that have limited external and fiscal buffers.

The prime minister’s decision to lower petroleum and electricity prices, if not limited to what was being envisaged, could have economic repercussions on multiple fronts. Pakistan does not have fiscal space. It is a politically motivated decision. Something similar happened in 2007-8 when the Musharraf government was losing popularity and decided to absorb massive subsidy on petroleum products in days of rising oil prices. Today, for the prime minister, the prime objective is to avert the vote of no-confidence.

However, current times are somewhat different and these need to be evaluated on their own merits. Inflation is already persistently high in Pakistan. The decision of lowering Rs10/liter on petrol/diesel prices is not a demand booster as lamented by some political analysts. This reduction in petrol prices would not enhance demand furthering inflationary pressures.

Let’s put the context straight. Petrol prices (after the decline) are still up by 33 percent in a year while diesel prices are up by 24 percent. Thus, even after the reduction, there is already no respite for consumers. Moreover, there is an indirect impact of inflation due to fuel prices hike. Just to give a perspective, wheat flour prices are up by 23 percent in the last 12 months, beef by 21 percent, and cooking oil by 45 percent.

The government’s actions aim to give breather to the masses. The question is whether the government has enough cushion at its disposal to do so. Tax collection growth is decent, again due to higher commodity prices. The government also has the requisite fiscal space by axing PSDP (Public Sector Development Plan). It can get by for four months, given that prices do not escalate too much. In that case, government must reverse the decision. The IMF (International Monetary Fund) is certainly not happy. However, the Fund can be convinced if government gets the fiscal (primary) deficits numbers right, and SBP (State Bank of Pakistan) takes appropriate monetary and exchange rate measures.

The situation today is not as bad as it was in 2007-08, when petrol and diesel prices were kept unchanged for a year from March 2007 to Feb 2008, while international prices almost doubled. The Price Differential Claim (PDC) subsidy peaked at Rs37/liter in June 2008. PDC is a subsidy. In terms of GDP and in US dollar, the subsidy element was much bigger at that time.

The relief of freezing prices till budget would have much lower consequence than what was the case in 2007-08, provided that the relief is for four months, as promised. At average price (for latest imports) of HSD at $119/barrel and $118/barrel for petrol, the PDC is at Rs13/liter and Rs8.4/liter respectively. And after incorporating customs duty (CD) at 10 percent (there was none in 2007-08), there is no subsidy yet at these prices. Net revenues, after adjusting for CD and duty on locally refined products, is Rs5 billion per month at last month’s consumption.

However, prices are moving up. On Friday (4th March) international prices touched $137/barrel and $125/barrel for diesel and petrol, respectively. If prices rise further or remain same, government will have to pay net subsidy of Rs17 billion per month. The equation has changed in the past few days. Will the government revisit its decision?

The bottom line is that neither the subsidy (at the time of decision) was big enough nor the demand would increase by this relief - given prices are up by around 30 percent in the last 12-months. However, given limited external space and the way international oil prices are moving, more is needed to curb demand. One step is to increase interest rates. Although it has its own merits, it would not be able to curb demand in the next few months, as monetary transmission takes time. The other element is to let the currency slip. This could curb demand in other areas, but petroleum demand will remain unchecked as prices are being frozen. And currency depreciation will bring more inflation home.

The government must look towards adopting administrative measures to curb demand. One idea is to adopt smart lockdowns. Shopping malls and shops should close earlier – such as by 6PM, on weekdays, and remain shut on weekends. The spring break in schools should be extended. Work from home should become mandatory where possible. Unnecessary travel should be restricted. The government should increase taxes on international travel, and have higher tax on international credit card spending.

The point is to reduce mobility and spending. Economic factors alone are not enough, and these have inflationary consequences. External account situation is bleak. With higher inflation and war in Europe, these are signs of exports orders slowing down. These will put further pressure on currency. Imports must be cut down. Use administrative measures to reduce mobility and curb unnecessary imports. Desperate times require desperate measures.

Copyright Business Recorder, 2022