In fiscal year July-June 2003-04, Pakistan's current account surplus fell to $1.806 billion from $4.07 billion in 2002-03. The current account surplus did decline primarily because the trade deficit more than tripled to $3.2 billion in the last fiscal year from $1 billion a year earlier.

The government has projected a trade deficit of $3 billion for this fiscal year with import and export estimates set at $16.7 billion and $13.7 billion respectively. But booming oil prices that shot up to $49.4 per barrel on August 20 threaten to widen the trade deficit.

That may not only further reduce the current account surplus or turn it negative but may also deplete the foreign exchange reserves that have already been on the fall.

Reserves fall: Pakistan's liquid forex reserves fell from an all-time-high of $12.601 billion at end-February, to $12.094 billion at end-July 2004, showing a decline of half a billion dollars in five months.

The reserve declined by $507 million mainly due to large trade deficit. The pre-payment of $1.17 billion expensive Asian Development Bank debts by the government, though made partly through a special fund created for this purpose, also slowed down the pace of reserves growth.

A huge outward remittance of $350 million through a consortium of banks to clear a Japanese debt of Pak-Arab Refinery Co or Parco in June also led to a fall in forex reserves.

Pakistan's trade deficit totalled $2.203 billion in July-March 2004, the period that saw a gradual decline in the reserves. (See Table 1) TABLE 1: Trade deficit March 2004 and July 2004

I. During this period, Pakistan spent $1.5 billion on import of machinery (including $688 million part-payment made by PIA for Boeing 777) and $1.3 billion on oil imports.

A $2.203 billion trade deficit in five months means an average monthly deficit of more than $440 million. This reflects an almost three-fold increase in the monthly trade deficit that averaged at $148 million between July 2003 and February 2004.

That explains why total liquid foreign exchange reserves that had shot up by $1.881 billion in eight months to February 2004, fell to $12.094 billion in five months to July 2004. (See Table II). Table-II: Pakistan's falling reserves.

Rupee weaker: The continual fall in the forex reserves took its toll on the health of the local currency. The rupee shed 107 paisa or 1.86 per cent of its value against the US dollar in five months, coming down to 58.42 a dollar at end-July, from 57.35 at end-February 2004.

Contrary to this, when the reserves were on the rise between July 2003-February 2004, the rupee had gained 46 paisa or 0.8 per cent value, moving up to 57.35 a US dollar from 57.81. (See Table III).

Future outlook: Several pointers, including booming oil prices indicate that foreign exchange reserves may fall further during this fiscal year. Though the trade deficit in July 2004 totalled $189 million indications are that from August it would start rising and would continue to expand till the end of the fiscal year in June 2005.

A key reason for this projection is booming oil prices. Oil prices for August-September 2004 deliveries showed a dramatic rise. This was mainly due to increased oil imports by China and India, economic recovery in the US and Japan and uncertainties \and speculations fuelled by the ongoing fighting between US forces and Iraqi armed militia.

Uncertainties and speculations preceding news of a four million tonnes cut this year in production of crude oil by troubled Russian oil giant Yukos also contributed to the oil price hike.

The increase in the August-September forward oil prices, upto 60 per cent compared with the end-June levels, is bound to inflate Pakistan's oil import bill thereby expanding the trade deficit. In the last fiscal year, Pakistan's oil import bill was $3.16 billion, one-fifth of its total imports of $15.473 billion.

The government has set the imports' target at $16.7 billion for this fiscal year. If the oil import bill remains unchanged at 20 per cent of total imports, it should be $3.34 billion based on last year's oil prices.

But since oil prices have risen from $30 a barrel at end-June to $47.8 for end-September 2004 supplies, after hitting a record high of $49.4 a barrel, oil import bill would likely be much higher.

The price of New York's Light Sweet Crude for October deliveries is also around $46 per barrel. Experts say this means that our oil import bill during this fiscal year may easily exceed $4 billion.

Inflation abroad: Rising inflation in the USA, Pakistan's biggest trading partner, would also expand our trade deficit during the current fiscal year. In January-July 2004, US inflation measured by CPI-U or Consumer Price Index for all Urban Consumers shot up at a 4.1 per cent seasonally adjusted annual rate.

This compares with a modest increase of 1.9 per cent for all of 2003. The index for energy, which had risen by 6.9 percent in 2003, increased at 25.9 per cent between January-July this year, data released by the US Department of Labour show. Petroleum-based energy costs rose at 44.5 per cent seasonally adjusted annual rate whereas charges for energy services rose at 8.9 per cent.

Economic recovery, amidst booming oil prices, in the leading economies may keep fuelling inflationary expectations for some time. That means inflated import bills for Pakistan as well as for other developing countries.

Inflation at home: The most adverse impact that the soaring oil prices may have on our economy would be on inflation. Consumer inflation shot up by 8.4 per cent in June and 9.3 per cent in July 2004 year-on-year, despite the fact the government kept domestic oil prices frozen at May 31 level.

The government had to reduce its Petroleum Development Levy to keep domestic oil prices unchanged in the face of rising international prices. Many say the government did this to gain political mileage.

But indications are that this practice would have to be discontinued in October-December. The reason is that if the government keeps collecting lesser amounts of PDL this would have an adverse impact on its revenues and widen the budget deficit.

So, whenever the government starts passing on the increased international oil prices onto the domestic prices, it would have an immediate impact on the price line and push inflation further up.

The target set for consumer inflation is 5 per cent for this fiscal year. But it seems next to impossible for the government to meet the target in the face of booming oil prices. The Asian Development Bank also said recently that inflation in Pakistan might exceed the target.

Key issue: The problem in tackling inflation is that if the State Bank raises interest rates too aggressively that seems inevitable to check inflation, it would slowdown the economic growth by reducing the potential growth in industrial output and exports.

And if, the central bank moves too slowly on increasing interest rates, inflation would keep rising, making lives miserable for the poor and exposing the new government of Shaukat Aziz to political risks.

Historically low interest rates in fiscal year 04 helped Pakistan's economy grow by 6.4 per cent; it pushed up large scale industrial output by 18.1 per cent and boosted exports to $12.27 billion from $11.16 billion a year earlier. The target for economic growth is 6.6 per cent for the current fiscal year.

Remittances: Though the workers' remittances or money sent back home by overseas Pakistanis went up by 10 per cent to $330 million in July 2004, soaring oil prices may reduce these remittances in the months to come.

Inflation may climb up in many parts of the world due to unusually high oil prices. That, in turn, may increase local expenses of expatriate Pakistanis making it difficult for them to send higher amounts of foreign exchange back home.

If that happens that too would take its toll on foreign exchange reserves and balance of payments position. But if Pakistan's economy performs better and if Mr. Shaukat Aziz's government wins confidence of expatriate Pakistanis, then workers' remittances may increase instead of falling.

Much would also depend on how Pakistanis are affected by the ongoing scrutiny of bank accounts in the US, Europe and the Middle East to check financial terrorism. If they feel they are being victimised, they may send higher amounts of foreign exchange back home.

The exchange rate premium in the open market would also determine the pace of inflow of workers' remittances. If the premium goes beyond 50-60 paisa a US dollar, then part of these remittances would be routed through unofficial channels. The government expects $3.5 billion income through workers' remittances during this fiscal year, down from $3.8 billion in the last year.