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Wednesday, January 12, 2011


Politicians are happy that they forced the government to withdraw its decision to increase petroleum prices and government is happy that they get their majority back.

The fact is, it might be a “popular decision” but it is a very poor economic decision and will have negative consequences on the economy. To understand this point we need to see the 2008 crisis. Musharaf’s popularity was decreasing, elections were near and oil prices were recording new highs once reached around 147$ per barrel and Musharaf’s regime decided not to pass on the increase to consumers just to save their deteriorating reputation. Fx reserves depleted and this was the time when rupee started to depreciate from 60Rs/dollar, fiscal deficit rose, inflation rose and stock market crashed. What happened was that government just did not pass on the oil prices to consumers and it did not have enough finances to back this decision.

Now consider the current scenario, the popularity of PPP (and its allies) is decreasing, and when MQM decided to quit government mainly because of current increase in oil prices government lost its majority in the parliament. So far, government is not able to increase taxes, inflation is increasing so does the interest rates, fiscal deficit is increasing, and the last but not the least government borrowing is increasing at an alarming rate and it is the government borrowing which is the root cause of all issues. One thing is quite clear here, government is almost in the same scenario and ironically, government decided exactly what a Musharaf’s regime decided just to retain their majority in parliament. The question is how will government finance this subsidy? International oil prices are hovering around 90$ (at their 26 month high) and government had to pass on this increase in prices to consumers but they decided not to do so. Now they will need to borrow more (as they are already borrowing more causing high inflation and high interest rates) from SBP, which will increase already high inflation (around 15.8%) and we could see what we have seen in 2008. As per Mr. Naveed Qamar (Petroleum Minister) if oil prices remain at current level then government will now have to suffer a loss of PKR 5 billion per month. Given the fact that government has already borrowed 250 billion so far (increasing at an alarming rate of 100% YOY) this decision will now compel to borrow for this “Petroleum Subsidy”. I think this will also hurt Pakistan’s reputation in the eyes of foreign donors and foreign investors (especially sovereign debt investors) as well. Remember government has not been able to bring any tax reforms, this subsidy is just not bearable. SBP will now print more money because of increased borrowing from government, which will be more inflationary than the impact of increase in oil prices. Remember, our fiscal deficit is now expected to be around 6% for FY 11 but some analysts expect that it might end up much higher.

The only thing that is different from 2008 crisis is strong exports, low imports, increasing remittances and IMF support. In other, words our current account is not as bad as it was in 2008 because of above mentioned issue.

I believe this decision in just not sustainable and government will not be able to keep this subsidy and will pass on it to consumers in future in a more efficient manner i.e. it will not remove it suddenly but incrementally.

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