Dr Ashfaque H Khan
Tuesday, April 03, 2012

The year 2007-08 was one of the most difficult years for world economy with fuel prices soaring to a historical high ($147 per barrel in July 2008) and food prices escalating to the highest levels in over 20 years, thereby creating serious hardships for the poor in developing countries.

The crisis of 2007-08 brought multi-dimensional problems for millions of poor including those in Pakistan. More than 26 million people may have lost jobs by the end of 2010, with millions who took decades to work their way out of poverty slipping back in a matter of months. In Pakistan, the crisis of 2007-08 suspended the growth momentum, led to the emergence of higher inflation, worsened both the fiscal and external account deficits, and pushed millions below the poverty line. The government has yet to release the basis data for poverty measurement, but it is justifiable to speculate that millions may have risen substantially.

Food and fuel prices are on the rise again, an issue of serious concern across much of the developing countries, including Pakistan, and a phenomenon very much reminiscent of the 2007-08 period. This ominous development is threatening to slow down economic growth, poverty reduction, and the achievements of the Millennium Development Goals (MDGs) in developing countries.

What is driving the recent surge in oil prices? In the aftermath of the 2008 global economic crisis, the price of oil dropped to $41 per barrel in early 2009, but then, fuelled by the sustaining dynamism of emerging economies, particularly Asia, the oil price rose to $122 per barrel in early 2011. A number of supply shocks, particularly resulting from geopolitical instability in the Middle East and North Africa have also contributed to the recent rise in oil prices.

High oil prices have emerged as the latest source of worry for the world economy. HSBC termed oil as the “new Greece”. The standoff between the West and Iran over its nuclear programme is raising further concerns about oil prices. The sanctions imposed by the West will be effective from July 1, 2012. If Iran retaliates and attempts to close the Strait of Hormuz (one-fifth of global supplies or 17m bpd of oil supplies passes through the Strait), the oil prices could reach as high as $150 per barrel with all its consequences reminiscent of the 2007-08 crisis.

The higher price of fuel is bound to increase food prices on several counts. It will increase transportation cost, push up the prices of agricultural inputs, which in turn would increase the price of food items. Increase in oil prices would indirectly lead to greater pressure on food prices through biofuels. It has generally been argued that oil prices, if rebounding to $100 or more, would make biofuel-use more economical, with adverse impact on the poor.

High food and fuel prices affect several macroeconomic aggregates directly or indirectly. These macro aggregates include consumption, investment, economic growth, inflation, trade and fiscal balances. The impact on overall inflation is straight-forward. In order to contain inflation, the central bank would increase the interest rate, which would affect investment and growth negatively. For food and fuel importing countries, increased import prices would certainly lead to deterioration in trade balance and consequent pressure on exchange rate. Fiscal balance would come under pressure when government implements social protection measures.

Increase in food and fuel prices would seriously undermine decades of poverty reduction gains achieved by the developing countries. Higher food and fuel prices will have a two-pronged effect on poverty. People who are unable to emerge from poverty due to lower economic growth, and people who are driven into poverty due to a fall in real incomes will be impacted the most. People who are already living below the poverty line may suffer greater hardship due to higher food and fuel prices.

Pakistan’s macroeconomic fundamentals have been weakened to the core over the last four years. Economic growth has slowed to an average of less than three percent with investment rate registering a 37 year low, unemployment and poverty increasing alarmingly, budget deficit remaining large, public debt more than doubling, and most importantly inflation, particularly food inflation, remaining in high double digits over the last 50 months.

The persistence of higher inflation, particularly food inflation, for such a prolonged period has totally devastated the poor, low income, fixed income, and even the middle income groups. The new round of fuel and food price hikes are likely to further crush these segments of society. The oil price in Pakistan is rising for multiple reasons. It is rising mainly because the international price of oil is rising. The depreciation of the exchange rate has increased the landed cost of oil as well. On top of this, a large number of taxes and charges on compound basis (tax on tax) have further increased the domestic price of oil.

While the economy and consumers are badly affected, the Federal Board of Revenue and the government are the major beneficiaries of the oil price hike. Tax revenue from the petroleum sector has emerged as one of the largest sources of the FBR revenue, accounting for almost 30 percent of the total revenue.

Failure of the government to bring hitherto untaxed or undertaxed sectors under the tax net has resulted in shifting of taxation towards the petroleum sector. This is unsustainable and will have a wide-ranging adverse impact on the economy. More so, it will have a devastating impact on poor, fixed and low-income groups and even put a severe strain on the middle income group.

I would urge the government to review its taxation policy on the petroleum sector, particularly the way those taxes are collected and other charges and commissions are determined. Achieving budgetary target of revenues through inflicting severe pain and suffering on the masses will not be treated as a victory. I hope sanity will prevail.

The writer is principal and dean of NUST Business School, Islamabad.

Email: ahkhan@ nbs.edu.pk
-The News