Do not flirt with petroleum prices

The international oil prices are hovering their seven year high, and the current government in Pakistan is entering its last years of tenure. The correct, but politically tough decision, is to pass on the increase to consumers.

In this way, the government will not have to compromise its tax revenues and at the same time, higher prices will lower consumption which will ease the current account deficit. However, the flipside is the direct and indirect impact of increase in the prices on the inflation. Not an easy decision.

The incumbents must learn from the mistakes of the then government in 2007-08. At that time, the government did not pass on the impact of oil price increase to consumers. Consumption grew unabated, and the government was losing potential tax revenues – at its peak in 2008 the petroleum differential claim (subsidy) reached Rs37/liter.

The twin deficits (fiscal and current account) ballooned. The currency had to sharply depreciate, and interest rates touched 15 percent. The supposed objectives were to win elections and keep inflation low. The government failed on both counts. They lost the elections, and the inflation was at 21 percent in the next year.

The message for the PTI government is to not repeat those mistakes. Last week, the government deferred the proposed increase by Ogra (oil and gas regulator) up to Rs14/liter. That is not the right decision.

To continue with unchecked demand could be a sure recipe for disaster. Some may argue that the increase in prices may not reduce demand much as petroleum consumption is less elastic. That is true; but there could be some impact, as the demand is not perfectly inelastic either. Plus, there would be no fiscal losses by passing on the impact to the consumers.

If oil prices increase further, it would be that much harder for the government to pass it on. The optimal option is to pass on the impact every fortnightly. Some may be expecting (rather wishing) the oil prices to come down from $90/barrel and that would neutralize the current policy of unchanged pricing. But what if oil crosses $100? With every dollar increase, the quantum of required increase to be passed onto consumers would be higher for the government. It should refrain from falling into the trap.

Then there are environmental concerns with increase in petroleum consumption which is primarily in transportation. Smog is in the fifth season in central and southern Punjab. Highest contributor to pollution in Punjab is transport. World over, private transportation on internal combustion engines is discouraged in cities for environmental reasons. This must be reduced.

The need is to improve the public transport system in cities to lower the load of private transportation. However, that cannot happen in a short time. And time is not in favour of this government. The PM fears losing political capital, as higher prices would make the already high inflation uglier. It’s tough but inevitable.

The government should also think of other ways to reduce the consumption of petroleum — such as, imposing congestion tax on busy roads in peak hours, enhancing the parking fees and toll taxes from cars and SUVs on highways.

The other side of the picture of passing on the impact to consumers is inflation, especially on the marginalized segments of the society. To counter this, someone in Economic Advisory Council proposed to give direct subsidy to bikers. That is not easy to implement, as this could be grossly misused. Plus, the subsidy element could be huge. Approximately 55-58 percent of petrol consumption is in 2/3 wheelers.

This must get lower, and the only sustainable way to do is improving the public transport system along with higher parking fees and tolls. These are in the domain of provinces while the pricing decision is federal. Coordination between provinces and federal government is imperative.

The other option to lower the indirect impact of transportation inflation is to have higher increase in petrol while not passing the full impact on diesel which is mostly used in public and goods transport. Both in India and Bangladesh, diesel prices are lower than petrol prices.

It’s the other way round in Pakistan. The delta is falling, and the government should slowly increase petrol prices relative to diesel’s. Though, that would hit hard on bikers.

That is why improving public transport is imperative in cities. That is how government could regain its lost political capital from the increase in petrol prices. Here the model of Punjab (which is being replicated in some parts of Karachi too) should be expanded.

Allocate the routes to private players and let them run buses on it. Encourage the use of EV buses and discourage the private use by charging congestion and parking fees.

All these need time and good management. Both are missing. That is why in the short-term increasing prices of petroleum is the way to go. Some economists may argue that this will bring inflation and in turn currency will depreciate or interest rates will move up – or a combination of both.

That argument is not plausible. As not passing the impact will hit the currency hard, interest rates and inflation – like was the case of not passing on the impact in 2007-08 on other macro variables in 2008-09. The government must swallow the tough pill today to save from hospitalization tomorrow.

Copyright Business Recorder, 2022