KARACHI, Aug 7: Economists in Pakistan are worried over the relentless rise in international oil prices, which they say could have negative repercussions on the country's economy. The Brent this week set a new all-time record of $41.5 per barrel. "If international oil prices average $35 per barrel throughout FY05, it would add approximately $600 million (net) in additional foreign exchange payments", calculated Sakib Sherani, chief economist at ABN AMRO Bank NV. He also pointed out that the government could also face a shortfall of approximately Rs25-30 billion in budget on account of lower Petroleum Development Levy (PDL) collection, the budget target for which was set at Rs47 billion.

International oil prices have been on the rise pretty much since early 2003, but they have climbed by a steep 36 per cent since January this year. Sakib observed that over the past few months, a string of unfavourable developments on the supply side had produced a volatile/self-fulfilling market psychology. Flow of oil had slowed from Iraq, Saudi Arabia, Venezuela, Nigeria, Norway and US refineries. Those had combined with demand factors, such as the highest increase in annual energy demand from China in 16 years.

With prices setting new records almost every week, market wonders what does that bode for Pakistan's economy? "Clearly the precipitous and unrelenting rise in oil prices has the potential to generate some very real negative effects regarding Pakistan", says Sakib. He points out that the transmission channels include: (i) Higher import payments (both for oil as well as other commodities that would rise in tandem); (ii) Possibly lower exports (if the global economy slows and partner country trade demand is effected); (iii) inflation (though the government's decision to freeze domestic petroleum prices has blunted a major portion of the direct impact on consumer prices); (iv) A higher fiscal deficit; (v) Higher interest rates (as a result of both of the above factors); and (v) Possibly slower economic growth & investment.

The ABN Amro Bank's economist broadly quantifies some of the direct effects of relentless rise in oil prices. These include: (1) If international oil prices average $35 per barrel throughout FY05, it would add approximately $600 million (net) in additional foreign exchange payments. The pressure would be exacerbated by the need to import furnace oil in FY05 due to lower hydel-power generation. "So far, our working assumption for world oil price for FY05 in our balance of payments model was $30/bbl. We have upgraded this to USD 35/bbl", he stated. (2) As a result, USD/PKR will face greater pressure than had previously been forecast. The magnitude and timing of which would depend on how quickly (& how much) GOP borrows externally. (3) By freezing domestic petroleum prices at current levels, GOP was providing an effective subsidy to consumers by absorbing the differential in the budget via the Petroleum Development Levy (PDL). "Our calculations suggest that if international oil prices average USD 35/bbl for FY05, Government could face a shortfall of approximately Rs25-30 billion in the budget via lower PDL collection (budget target for PDL in FY05 is Rs 47 billion). (4) Both the pressure on the exchange rate & the need to find alternate budgetary resources to fill the potential gap under the PDL head, could result in stronger upward pressure on interest rates than currently forecast. Once again, the extent of GOP's external borrowing (or some other measures to protect the deficit) would determine the final magnitude of impact on interest rates and (5) All the above would clearly have important second-round effects as well, notably on investment and GDP growth.

Abdul Rasheed, analyst/economist, who follows the energy sector for stock brokerage firm, InvestCap, said that higher crude oil prices would have two-fold impact on the local economy. Pakistan imported $3bn (19% of total import bill) worth of crude oil and other POL products during FY04. If current high oil prices remain constant throughout this fiscal year, oil import bill was likely to touch $4bn in FY05. That would upset the government target of trade deficit of $3bn for FY05 ($3.2bn in FY04).

"Increasing trade deficit is and will put pressure on rupee-$ parity and we have already seen rupee devaluation compared to US$", said the analyst. He referred to the pass on effect that would result from increasing oil prices as they would impact prices of other products as well, such as petrochemicals. All of that would have an inflationary impact. "And higher inflation has the tendency to cause higher interest rates", said the economist.