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The price of
crude registered a whopping $119.90 this week, the highest ever. The causes
behind this rise are several. The most obvious one is linked to emerging world
supply constraints. An attack on a Nigerian pipeline which was to transport oil
from a 400,000 barrel a day oil field to Royal Dutch Shell PLC was blown up last
week.
In Mexico, oil production declined by 7.8 percent in the first quarter as output
in the oil fields diminished. In Scotland, the threat of strike action over
changes to the employee pension plan in the 196,000 barrel a day Grangemouth
refinery and petrochemical plant raised concerns of further world supply
constraints, pushing up international prices further.
Iraq, with the world's second largest proven reserves, is facing its own
problems. During the Saddam era French, Russian and Chinese companies had won
major contracts; however, UN sanctions kept these contracts inoperable. Since
the US invasion the Americans are pushing for their own companies to gain most
of the lucrative oil contracts estimated to be worth billions of dollars.
In this context, US advisors exerted considerable 'influence' through the 2005
Iraqi constitution to guarantee a major role for foreign companies. The Iraqi
cabinet endorsed this draft law in July 2007; however, parliament has not yet
passed it as the majority of Iraqis as well as the powerful oil workers' unions,
opposes denationalisation.
And, finally, while the possibility of a war with Iran appears to be receding as
the days of the Bush administration are numbered, yet threats and
counter-threats continue to create uncertainty in the market, which is an
additional contributory factor to the oil price rise in recent months.
Another reason for the oil price rise is associated with the fact that several
investors consider oil as a hedge against inflation and a falling dollar. And a
weaker dollar makes oil cheaper for investors overseas.
In this context, it is relevant to note that the greenback fell further this
week after the National Association of Realtors stated that sales of existing
homes dropped in March, while the median home price declined, raising prospects
that the Federal Reserve will cut interest rates further this year to try to
shore up the ailing US economy. Fed interest rate cuts tend to further weaken
the dollar.
Whatever the reasons behind the rise in the price of oil internationally,
factors that are external to decision making in Pakistan, it is, nonetheless,
pertinent to note that the impact on our fragile economy is going to be
considerable.
The first impact is direct and instantaneous: the rise in price of oil will
raise the import bill and, without a commensurate rise in exports, the balance
of payments position will worsen, putting further pressure on our rupee. This
increase in local price is further exacerbated by the diminishing value of rupee
vis-a-vis the US dollar. In the month of March alone the oil import bill
increased by 101 percent compared to the corresponding month last year.
Second, the impact on domestic inflation is going to be considerable, especially
if the government moves to end the subsidy on oil - a subsidy supported by the
previous government prior to elections for political reasons.
Those who argue that some form of subsidy must remain should be aware that a
higher budget deficit, due to the subsidy, may well raise inflationary pressures
by more than that if the oil price was raised to reflect the international price
rise.
Pakistan, like other developing countries, has to bear the cost of an oil price
rise in the short to medium term. In the long term, greater reliance on other
cheaper alternate sources of fuel maybe possible with ongoing research and
development in the area; however, at the present time, the only focus of the
government needs to be on promoting productivity and thereby propelling the
growth rate, and not promoting growth through foreign and domestic borrowing as
was done by the previous government.
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