Oil price volatility impacts Pakistan’s economy

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ISLAMABAD: Oil price volatility impacts Pakistan’s economy, WealthPK reported on Monday.

Pakistan is largely an oil-importing country to run the wheels of its economy.

The transport sector is the largest consumer of oil products followed by power and industry. According to the Oil and Gas Regulatory Authority, 81% of oil was consumed by the transport sector, 9% by power and 8% by industry during the fiscal year 2019-20, WealthPK reported.
Pakistan’s oil consumption during the first quarter of the ongoing fiscal year 2021-22 (July-October) grew 24% from the year-ago period to 5.9 million tonnes on a combination of a rebound in industrial and transportation activities as well as rising demand for fuel oil. Pakistan imported around 10 million tonnes of oil in FY2020-21, whereas the domestic production is static at 83,000 barrels per day.
Pakistan’s total oil import bill rose by 113% to $10.2 billion in the first six months (July-December) of FY2021-22 from $4.77 billion during the same period last year.
During the early stages of the Covid-19 pandemic, the oil prices in the international market drastically dipped to less than $20 a barrel as a large number of businesses were shut down around the globe and the majority of the workforce was either laid off or worked from home.

This significantly reduced the demand for oil in terms of transport consumption and electricity usage. After the Covid-19 vaccine was developed, things started normalising. Oil prices increased due to an uptick in economic activity causing a sharp rise in demand.

The continuous rise in oil prices internationally has worsened Pakistan’s balance of payments as rising oil prices increases the import bill, causing the budget deficit.

When the government subsidises domestic oil prices, the volatility of international prices is transmitted into volatility in the actual government spending. This situation leads to difficulties in managing fiscal programmes, which tend to be planned a year ahead and are based on estimates of average oil price.

There is a positive relationship between oil prices and inflation because oil is used to produce and transport products. So, any increase in oil prices in the international market increases the commodity prices. This can be seen in the graph below that illustrates how the international oil prices affect inflation in Pakistan.

However, the reason for a negative relationship between inflation and oil prices in the fiscal year 2020 was the Covid-19 pandemic, which caused a reduction in global oil consumption, but increased both the demand and prices of food and other essential items as the world saw massive supply chain disruptions.

An expansionary monetary policy can be a short-term solution to curb imports to reduce the impact of increasing oil prices on inflation. However, the government will have to formulate a policy framework to counter this impact in the long run.
Pakistan can cut reliance on imported fuels by focusing on renewable energy such as wind, solar and hydro. It is to mention here that the country spends a fair share of diesel and furnace oil on producing electricity.

Pakistan will also have to take drastic measures to introduce and promote the use of hybrid and electric vehicles to drastically bring down the oil import bill and thus prevent imported inflation.
Another way to manage the price volatility is to give incentives to the private sector to hold strategic stocks of major food items to be used in emergencies. -INP