'High oil prices may raise inflation to double digits'

High oil prices in international market may raise inflation to double digits and may have adverse effects on economic growth, as $1 per barrel increase in crude prices translates into 0.29 percent increase in Consumer Price Index (CPI), economists say.
Sources told Business Recorder said that though Pakistan's economy was growing rapidly, the increases in oil prices globally were upsetting the economic managers.
Sakib Sherani, Chief Economist at ABN-Amro Bank, addressing a forum on 'Current State of Pakistan Economy and Outlook', said that Pakistan's economy had performed very well during the last five years. It achieved 8.4 percent growth rate; privatisation process had a kick-start ($4.3 billion during 2002-05); and foreign exchange reserves were bulging above $12 billion (capable of eight-months imports).
Besides, FDI grew to above $1.5 billion and the government was focussing on energy, agriculture, SMEs and information technology sector to further boost the economy. Public debt is on a rapid downward trajectory and its ratio to GDP has come down to 60 percent in 2005, as it was about 120 percent previously.
However, he said, the economy had "over-heated" after rapid growth, which increased inflationary pressure. There was robust credit growth and imports went up by 37 percent.
He said that the Asian Development Bank (ADB), in its recent report, had also forecast that Pakistan's Gross Domestic Product (GDP) in fiscal 2006 might slip to 6.5 percent due to high oil prices, compared with 8.4 per cent growth last year.
While fearing decline in growth, the government is planning to reduce its oil consumption and switching to alternative energy sources, particularly natural gas and coal.
The economic managers are of the view that the country's reserves are holding stable and economy, otherwise, is looking promising. Yet there is the danger of high inflationary pressure on the economy.
The bank said that projections for imports, fiscal deficit and inflation might have to be revised upward due to surging oil prices. According to bank estimates, Asia produces just 10 percent of world crude oil supplies but consumes 24 percent, which is driving up the oil prices in the region. Asia remains particularly vulnerable to an oil shock because of its high dependence upon oil imports.
The estimates of the independent economist show that year-on-year international oil prices have surged by over 60 percent and at this rate world oil prices were edging ever closer to the all-time inflation-adjusted high of $86 per barrel (touched briefly in 1980). However, they say that despite current unfavourable dynamics on both demand and supply sides, that record may yet remain unbroken.
According to them, at an average of $60-65 per barrel oil prices can shave up to 0.7 percent off FY 2006 growth. The final outcome will be contingent on the extent of absorption by government of Pakistan of the oil price rise in the budget.
However, they view that full adverse impact on growth will potentially be cushioned by the strength of the services sector. (On the flip side, the high base from FY05, combined with lower cotton output expected this year, are important cyclical drags to FY06 growth).
They forecast 6.3-6.7 percent growth for FY 2006, as against (an earlier estimate of) 7 percent, and say that the trade gap is likely to be wider by approximately $2.4 billion (over FY05)--at around $8.7-9.0 billion.
About current accounts situation, they forecast that it would remain approximately $ (minus) -4.5 to (minus) -4.8 billion (nearly 4 percent of estimated FY06 GDP).
However, this assumes only a moderate slowdown in final demand for oil/petroleum products. Should aggregate demand in the economy fall off dramatically at current level of international prices, the oil import bill, and hence the current account deficit, could be significantly lower.
About dollar/rupee ratio they say that in the absence of offsetting flows, the substantially larger foreign exchange financing need on the external account side will pressure the dollar/rupee, which is now estimated to depreciate by approximately 3-5 percent for FY06 (Rs 61-62/$ by end-June 2006).
However, a more active privatisation program and/or larger foreign direct investment (FDI) plus portfolio inflows coupled with larger-than-anticipated financing from international capital markets could be important mitigants (mitigators).
Our take on the likely impact on Pakistan follows. We have pared our growth forecast for FY06 to reflect these realities. Revised forecast: 6.3-6.7 percent (from 7 percent earlier).
1. INFLATION: Our work on passthrough impact suggests the following econometric result: each USD1/bbl increase in int'l oil price translates into, on average, a 0.29 percent increase in domestic CPI.
While food prices, going forward, are a major wildcard, and may drag overall CPI inflation lower on the back of improved supply, we believe there is substantial impulse from the demand side to continue generating price pressures in the economy for the rest of FY06.
REVISED FORECAST FOR CPI INFLATION FY06: 9-10 per cent (previous: 8 percent).* *A major assumption here is that the int'l oil price (Brent) settles in a US$60-65/bbl range for FY06, and that the govt. passes on 50 percent of the increase into domestic retail prices.
2. BALANCE OF PAYMENTS: The trade gap is likely to be wider by approximately $2.4 billion (over FY05)--at around $8.7-9.0 billion.
3. CURRENT ACCOUNT FORECAST: Approximately $-4.5 to $-4.8 billion (nearly 4 percent of estimated FY06 GDP). However, this assumes only a moderate slowdown in final demand for oil/petroleum products. Should aggregate demand in the economy fall off dramatically at current level of int'l prices, the oil import bill - and hence, the current account deficit, could be significantly lower.
4. USD/PKR: In the absence of offsetting flows, the substantially larger Forex financing need on the external account side will pressure the USD/PKR, which we now estimate to depreciate by approx. 3-5 percent for FY06 (Rs 61-62/$ by end-June 2006). However, a more active privatisation programme and/or larger FDI + portfolio inflows, coupled with larger-than-anticipated financing from int'l capital markets could be important mitigants (mitigators).