Data on average oil consumption during the last 14 years shows that transport sector takes the lead with 48.7 percent, followed by power and industry with 31.1 and 12.5 per cent, respectively.
Surging oil prices and a corresponding increase in operational costs of the three key sectors, with combined oil consumption exceeding 90 per cent of total domestic consumption, pose serious risk to economic growth.
A rise of $5 per barrel in the global prices, if not passed on to domestic consumers completely, would cause an approximately 1.45 percentage point rise in the headline CPI, all other factors holding constant.
Moreover, devaluation also raises the price level as a one per cent fall in value of rupee causes inflation to the tune of three per cent on account of multiplier effect. During the last fiscal year, the dollar rose by 2.6 per cent against the rupee, while it is likely to range between 3-5 per cent by the end of current fiscal year.
Henry Wallich, in his statistical analysis using data for 43 countries and looking at other relevant factors, found that an increase of one per cent in the rate of inflation per year was associated with a reduction in the rate of growth of 0.03 or 0.04 per cent.
This may seem to be a small effect, but at a rate of inflation of 15-20 per cent per year it would imply a reduction of more than 0.375-0.5 per cent per year in the rate of growth. Thus, a prolonged high inflation would yield a significant difference in the increase in the income level.
Inflation rate on year to year basis during July-April 2004-05 has increased at a much faster pace in the range of 7-11 per cent mainly because of higher increase in food price, which, with the exception of December 2004, remained at double digit level.
According to the data released by FBS, inflation rose by 8.71 per cent year-on-year during July-August 2005.
A review of inflationary trend during (July-April 2004-05) across the four income groups with income limits of Rs 3000- Rs 12000 per month, indicate a higher incidence of inflation (10.4 per cent) on lower income group’s i.e. up to Rs 3000. Since low-income groups spend a major chunk of their income on food items, doubling of food inflation has added to their saga of sufferings.
Fixed and low income groups particularly government employees have ended up with illusion of money as soaring prices have tended to neutralize the 15 per cent raise in their salaries given in the budget 2005-06.
With inflation also goes up the cost of doing business. Inflation distorts the costs and prices, which adversely affects operational efficiency, economy and effectiveness of investors’ decisions. This discourages long-term investments, which in turn causes stagnation in industry and restricts their potential to generate employment, compounding the problem of poverty.
In such a situation, temptation to profiting from capital gains take precedence over production-related gains. This not only encourages speculation, hoarding and huge inventory build-ups but also keeps the capital diverted from productive investment avenues. The recent boom in property and stock market and spiralling prices of food items is a clear manifestation of this malaise.
Moreover, excessive dependence over indirect taxes also fuels inflationary fire. Indirect taxes, which account for two-thirds of our total tax receipts, tend to raise domestic costs and prices relative to international prices thereby discouraging production for export and encouraging imports.
Textile industry, which earns nearly 70 per cent foreign exchange and employees 35 per cent of labour force may be hit by high production cost, higher export refinance rates, rising BMR and shipping costs. It may reduce our competitiveness in global market and raise doubts about achieving $20 billion export target set for 2005-06.
According to a Switzerland-based World Economic Forum’s recently released Global Competitiveness Index covering 117 economies, our position is 83rd, much behind India and China securing 49th and 50th place respectively. As regards technology and macroeconomic environment, our economy stands at 80th and 69th place respectively.
Our exports of relatively high priced and low quality products face a high risk of being crowded out by cheap and high quality products particularly from China and India because their governments have significantly absorbed oil shock thus keeping inflation in single digit. This has helped their industry keep their cost of production lower than that of ours, thereby helping them retain their competitiveness in the international market.
As high cost of doing business dampens demand and erodes corporate profitability, attracting optimal foreign investment may become an uphill task. As a result the pace of growth in export of value-added products, which is currently less than $3 billion, is also likely to slowdown. . Since 1998-99, the terms of trade( ToT) has not only remained unfavourable, but also witnessed continuous deterioration. It is a reflection of our weakening position in global trade.(ToT) with base year 1990-91 (equal to 100) aggregated to 76.5 during July-December 2004-05 as compared to 79.7 during the corresponding period last year, showing a deterioration of four per cent.
Increase in the cost of transporting of industrial raw material/finished goods and agricultural produce is pushing up the prices of all consumer items including food items.
The power tariffs are also likely to go up by five per cent as Wapda generates 60 per cent of its thermal power from furnace oil and its price has increased by Rs6000 per ton. It is against this backdrop of soaring transport and power costs that cement manufacturers have hinted at raising cement prices despite the fact that 80 per cent of the industry has switched over to indigenous coal from furnace oil.
Households, industry and agriculture consume a major chunk of 41.4 per cent, 31.3 per cent, and 14.1 per cent of electricity respectively. With transport rates already increased, hike in power tariffs would further squeeze a vast majority of households, 51 per cent of whom, according to Pakistan Social Living Standards Measurement Survey 2004-05 remained deprived of fruits of high growth while the economic fortunes of over a fifth of population dwindled further.
Mounting cost of industrial production will have a dampening effect on demand at home and abroad. The capacity utilization and expansion in industry, which was boosted by easy monetary policy pursued during last couple of years, may lose pace thus compounding the problem of poverty and unemployment and worsening the balance of payments and intensifying shortages of foreign exchange.
With imports and exports estimated at $28-29 billion and $18-20 billion respectively, trade gap is likely to be $8.7-$9 in the current fiscal year, which will put foreign exchange reserves under pressure.
The trade deficit during the first two months of the current fiscal year has soared by 176.27 percent over the same period last year. Total liquid foreign exchange reserves are showing a downward trend.
The trade and current account deficit hit $6 billion and $1.526 billion respectively in 2004-05. Current account deficit in 2005-06 is forecast to range between $4.5-4.8 billion assuming an oil price at $60-65 per barrel. If the prices go beyond this level, the deficit may rise further. The government, groaning under huge shortfall in budget, may find it increasingly difficult to absorb any further increase in oil prices. The result may be a devastatingly hyperinflation eating up growth like termite.
Additionally, in response to persistent price pressure, the State Bank of Pakistan also began a measured tightening of monetary policy from around July/August 2004. Between July 1 2004 and May 20, 2005, the SBP has increased the yield on T-Bills between 7.07 and 7.91 per cent depending on instrument’s maturity. In order to signal a shift in monetary policy stance, the central bank raised the discount rate on April 11, 2005 by 150 basis points from 7.5 to nine per cent.
This was the first change in the key policy rate of the economy since November 2002. As a result, the weighted average lending rates have risen by 152 basis points during July-March 2004-05. In fiscal year 2005 ending in June last, the benchmark six-month Kibor shot up from 2.90 per cent to 8.71 per cent showing a big rise of 581 basis points. But in the first two months of this fiscal year i.e. in July-August 2005 six-month Kibor rose by only 16bps to 8.87 per cent.
Since the banks charge premium ranging between 2-4 percent on loans to corporate sector, their cost of capital has gone up substantially which is likely to discourage private sector borrowing from banks, thus causing a slow down in business activity. Moreover, following hike in yields on PIB, the rate of return on all products of NSS, with a portfolio of around Rs1 trillion, also saw an upward revision in the range of 0.96-2.04 per cent. This would raise government’s cost of domestic debt servicing that would ultimately widen budget deficit.
In such a situation, development budget bears the brunt of cuts in development spending, which means more miseries to the poor and less spending on infrastructure. The SBP has also raised export refinance rate from July 1, to 9 per cent from eight per cent. With bank rate hike, the export refinance rate has also risen substantially. This would adversely affect the exporters ability to compete in international market.
Easy monetary policy over the last three years did contribute to a high inflation in economy, but now it is soaring oil prices fanning the flames of inflationary fire. Therefore, change in monetary policy stance alone is not going to help contain inflation. Rather, the remedy lies in developing alternate energy sources so as to reduce excessive dependence on oil as a primary source of energy.
As natural gas reserves discovered so far may last for only about two decades, increasing the share of gas in overall energy mix, which is already as high as 47 per cent, faces constraints while on Hydropower projects a consensus is yet to be evolved among the stakeholders.
Thus coal power remains to be the immediate and viable option to meet the growing need of cheap energy for sustaining the economic growth. Thar coal reserves of 175 billion tons and with a low sulphur content of 1.6 per cent is an economic blessing which has, on account of policy wrangling and red tape, hitherto remained unexploited for which our economy and poverty ridden masses are paying a heavy cost.
In addition to that, the use of ethanol as a motor fuel needs to be focused on a priority basis. Ethanol fuel has gained a lot of ground in Brazil, USA, China, EU, Sweden, India, Australia and Thailand. Ethanol can be very easily blended with motor petrol. Our petrol consumption during 2005-06 is estimated to be 1.6 million tons. Thus blending of ethanol with petrol in the ratio of one per cent would result in petrol substitution to the tune of 16000 tons. The era of cheap energy is really over. We should waste no time in developing alternate energy sources with special emphasis on utilizing huge coal reserves to maximize cheap energy supplies for a growing, prospering and shining Pakistan.