Oily slope

All the international commodities are having a bull run. Oil is no exception and is the most critical commodity especially for oil importing countries like Pakistan. The government in Pakistan to counter rising inflation is not passing on the impact of increase in oil prices to consumers by compromising on the revenues in the form of petroleum levy (PL). This is a dangerous policy. It has been tried and tested in the past and has proved to be a failure- 2008 crisis was primarily driven by a sudden spike in oil prices. That can happen in 2022.

Brent oil prices have crossed $70/barrel last week. It has been on a rise since Nov 20 without a break. At that time, the ex-refinery price of petrol was Rs47.5 per liter (ex-refinery price is determined based on international oil prices in the last two or four weeks) and today the ex-refinery price is up by 63 percent to Rs77.5/liter. However, the consumer price of motor spirit (petrol) is up by a mere 6 percent. That was only possible on compromising PL. The story for diesel is similar.

PL collection target was set at Rs450 billion for FY21. The first two quarters were on bang as government collected Rs136 billion and Rs139 billion each in a quarter. The third was slow as government fetched mere Rs93 billion. The collection in 9MFY21 is at Rs369 billion. The fourth quarter is bad as PL collection is falling with rise in oil prices. The government is surely to be short of revenue target but by not much. The question is what will happen in FY22.

PL is now termed as non-tax revenue. It is not part of the FBR and is not shared with provinces under federal divisible pool based on 7th NFC award. Federal government needs such kind of revenues to reduce its growing need of expenditures. Growing fiscal deficit invariably fuels inflation. The other and bigger problem with higher oil prices is growing imports bill and that undermines the balance of payment strength- it is the weakest link in Pakistan’s macro picture.

Petroleum products (especially petrol) consumption is not inelastic. The consumption growth is linked to GDP growth (overall economic prosperity) and the consumer prices. Pakistan historic consumption suggests the same. Hence, if oil prices are not passed on, the government will not only lose fiscal revenues but the balance of payment strain will increase as well. Further the price increase is delayed, higher will be the impact on the economy. It is an imported commodity and has a strain on the environment. Its consumptions should be discouraged anyways.

The government was collecting total revenues (GST plus PL) at Rs44.6/liter in Nov20 and in Jun21 the collection is reduced to Rs20.6/liter for the first two weeks. GST rate is fixed at 17 percent and is part of federal divisible pool. PL is being compromised. Some say that it is fine to keep prices unchanged as government is only losing on PL which is an opportunity cost. Unlike 2008, government is not giving any subsidy on it. The main objective is to counter inflation and it is fine to lose revenues to curb inflation.

Well, that argument could well get the government in a trap. The forecast of international oil is bullish. The world is not yet fully open and Brent prices are north of $70/barrel. The forecast is of further increase – there are even calls of it is going up to $100 in this bull run. Technical gurus say that the oil spike accelerates when the prices moving up.

If the forecasts are considered true, soon the government will lose PL cushion at all. Approximately 5 percent increase in international oil prices will take the PL to zero if the petrol prices are kept unchanged at Rs108.6/liter. Government cannot reduce the GST and it must increase prices. Then the pressure of IMF will build on generating revenues and sooner or later government has to revert back to PL.

If the past is prologue, oil prices will shoot and spike in the next few quarters and the government will have to increase the petroleum prices or to provide subsidy (unlikely). Had the government been slowly increasing the prices, by marginally lowering the PL, it would have a cushion to smoothen out the future increase. The room is shirking fast.

Government probably was of the view in Nov20 that oil price increase would be for a sort time and once prices are back, we will be able to fetch higher revenues. But that is not happening. In 2007-8, the then outgoing government had a similar idea. In second half 2007 oil prices remained between $70-90/barrel and wasn’t an immediate big worry that time. 2008 started with sudden spike and by mid-2008 prices (May to July) on average prices were north of $130/barrel. The subsidies at that time and higher import bill were enough to create a massive crisis.

The government today needs to learn from that mistake. It should start creating room by jacking up domestic petroleum – petrol and diesel prices to counter any situation like first half of 2008. A better option is to simply deregulate the market and come out of the responsibility of fixing prices. Earlier government used to fix prices once a month and now it is happening fortnightly. In many economies – including India, prices change on daily basis and any change is gradual and doesn’t hurt much.