The meetings between the IMF staff and the government’s economic team came to an end in Doha on the 25th of May. The IMF mission leader has issued a statement in which it has been made clear that successful conclusion of the seventh review of the existing IMF Extended Fund Facility requires urgent and concrete policy actions, including removal of fuel and energy subsidies given in February and a strong Federal budget to reduce substantially the fiscal deficit so as to achieve the programme objectives.
The statement concludes with a positive statement whereby the IMF mission looks forward to continuing the dialogue and close engagement with Pakistan’s government on policies to ensure macroeconomic stability for the benefit of all citizens of Pakistan.
The earlier visit to Washington by the economic team had also concluded on a positive note. The Finance Minister had indicated that the IMF was willing to consider extension of the time period of the programme up to June 2023, with an additional loan facility of $2 billion. Apparently, some assurance had been given on fast movement on withdrawal of the fuel subsidy.
However, prior to his departure for Doha, the finance minister had indicated that the government is not willing to withdraw the subsidy. Nevertheless, it appears that the interaction over the three days from the 23rd to the 25th of May were of a constructive nature.
The mission statement appreciated the step taken by the SBP to raise the policy rate by 150 basis points on the 23rd of May to the high level of 13.75 percent. The Monetary Policy Statement issued following this decision assumes continued engagement with the IMF, including reversal of fuel and electricity subsidies together with normalization of the petroleum development levy and GST taxes on fuel during FY 2022-23. Consequently, the expectation in the MPS is that headline inflation is likely to increase significantly and may remain elevated throughout the year.
The MPS does not present an estimate of the extent of increase in the rate of inflation due to the withdrawal of the fuel subsidy. The time has come to highlight the pros and cons of withdrawal of the fuel subsidy, especially in the context of the continuation of the IMF programme.
The estimates are that on average the price of petroleum products would have to be raised by over 45 percent for the subsidy to be removed. The recommended pricing policy in the event the subsidy is withdrawn is to raise more the price of motor spirit consumed more by motor vehicle owners, whereas HSD oil is used largely by trucks for transportation of basic consumer and other goods.
A 35 percent increase in the price of HSD oil and a 55 percent increase in the price of motor spirit are likely to lead to both the direct and the indirect increase combined in the level of the consumer price index of up to 6 percentage points. This is a sizeable impact.
The absorption capacity of consumers will be greater if the increase in prices is spread over at least two moves. This will imply that the CPI will initially be higher by 2.5 percentage points and by 6 percentage points after the final move. Thereafter, no significant increase in petroleum prices would be required if the international crude oil price remains close to $110 per barrel.
Of course, some mechanisms will be required for relief to low-income households and for motorcycle owners. There are currently 23 million motorcycles which are two wheelers that are registered and close to 1 million three wheelers.
The Benazir Income Support Programme coverage would need to be increased to cover households with income level up to Rs 35,000 and/or registered owners of motorcycles provided an appropriate cash subsidy.
There is need to recognise that if the petroleum prices are raised sizably in 2022-23, this will not be the first time. After the colossal jump in the international oil price in 2008 to $140 per barrel the domestic price of motor spirit was raised by 40 percent and that of HSD oil’s by 54 percent. Also, currently these prices are exceptionally low in Pakistan.
The price per litre of motor spirit in equivalent US$ as of 23rd of May is $0.75 in Pakistan, $1.01 in Bangladesh and $1.34 in India. Similarly, the price of HSD oil is $0.72 in Pakistan, while it is $0.91 in Bangladesh and $1.21 per litre in India.
The other option is continuation of the policy adopted by the government which is to leave the petroleum prices at the level following the reduction of Rs 10 per litre on March 1, 2022, out of fear of the inflationary impact and adverse political fallout.
There is need to realize that this policy also has a very high cost. The balance of payments position is very fragile and foreign exchange reserves can provide import cover for just over one month. The suspension of the IMF programme due to non-implementation of the prior action of reducing fuel subsidy will expose the country to greater risk to a failure in honoring external payment obligations because of a big reduction in inflows from multilaterals, international commercial banks, etc.
The rupee which has fallen by 8 percent since the 1st of April will fall even further. This will contribute to more inflation. Also, the Government has opted for a policy of physical ban on 38 luxury imports. This is not adequate, and the level of imports will have to be curtailed by over 15 percent in relation to the present level, effectively by over $1 billion per month.
The two instruments of higher policy rate and deprecation of the rupee will have to be used strongly. The BNU econometric model estimates that achievement of the target reduction in imports will require the policy rate to be raised to 15 percent and the rupee to be depreciated further by over 20 percent in the earlier part of 2022-23. These moves will contribute to a big jump in the rate of inflation. The depreciation of the exchange rate will also be more regressive in nature because of the resulting big increase in imported food prices.
On top of all this, keeping the petrol prices constant will require an annual subsidy of over Rs 1200 billion in 2022-23. This will add substantially to current expenditure and increase the budget deficit by over 1.5 percent of the GDP. The financing will come pre-dominantly from domestic bank borrowing which will add to the money supply and cause over 2.5 percentage points increase in the rate of inflation.
After evaluating the above pros and cons, the Government has opted for the first option of raising the prices of petroleum products by Rs 30 per litre. This will increase the prices of petrol and HSD oil by 20 percent and 21 percent respectively. This could add over 2.5 percentage points to the rate of inflation. Also, coverage of the BIS programme is being increased and the monthly cash transfer raised by Rs 2000 per month.
The issue is if there will be subsequent increases and of what magnitude in petroleum prices. Will the forthcoming Federal Budget include another increase in prices and will the sales tax be imposed once again on petroleum prices? Clearly, there is no case for a petroleum levy given the high international price of crude oil.
The government has finally taken a sensible decision. We wish it success in its future efforts.
Copyright Business Recorder, 2022