The downward spiral of oil prices in the international market should be seen as a blessing for a country like Pakistan that is energy-starved and banks heavily on oil imports from global markets.
It has, however, created nervousness in the government that sees the fall in global oil prices and other commodities as a threat to its revenue efforts as the country heavily relies on taxes on international trade for revenue generation. Pakistan collects 48% of its total revenue by levying customs duties and other taxes on imports.
In the last one and a half year, prices of oil in the international market have gone down by 75%, falling from $110 per barrel to below $28. At present, they are hovering around $30.
With sanctions from Iran being lifted, an addition of four million barrels per day is expected, which will further put pressure on oil prices. Some analysts predict that prices can go down to $15 as soon as Iran starts pumping crude into the international market.
In the policy circles of Islamabad, heated debates are going on about how much of the reduction in world crude prices should be passed on to end-consumers. Pakistan is under the International Monetary Fund’s (IMF) programme, where it has to achieve stringent revenue collection targets.
It has shrunk the policy space for the government, which sees taxes on international trade as an easy and less costly means to achieve the revenue targets.
To meet the targets of the second quarter of the current fiscal year, the government introduced a mini-budget by raising import tariffs that included an increase in customs duty and imposition of regulatory duty on a large number of items.
On the import of petroleum products, the government is continuously increasing sales tax to meet the revenue targets. At present, sales tax on certain petroleum products is at its historic peak. Some analysts believe this rate of tax is unprecedented and equivalent to anti-consumption and luxury tax imposed to discourage consumption of certain products.
Pakistan’s economy has suffered due to increasing costs of energy and petroleum products. This has created challenges, especially for the export sector, in the global markets despite the country’s competitive advantage in certain textile products and agricultural commodities.
The industry would definitely like the government to pass on the benefit of lower oil prices to be able to reduce production costs and enhance competitiveness.
Price crash study
A number of economists have empirically proved that the fall in oil prices is good for economic growth. They developed their models by analysing the substantial reduction in oil prices in the mid-80s due to the supply glut.
Economic scholars concluded that a 10% reduction in oil prices could enhance economic growth by 0.5 percentage point.
As global crude prices continue to fall, it is unclear as to what extent the government would keep increasing import tariffs, especially sales tax, on oil products. In the short run, there may not be many policy options, other than raising import tariffs, due to lack of capacity and a narrow space for collecting direct taxes.
However, one thing is clear that as the import tariff rises, revenues increase to a certain extent. Beyond that, further increase will bring the revenues down as economists explain this as “tax elasticity” and its impact on consumption.
The higher import tariffs will also create economic incentive for smuggling and may divert imports to the Afghan transit trade. There are already persistent complaints of diversion of transit goods to the domestic economy due to porous borders. Oil smuggling from Iran is also rampant and is meeting domestic needs in areas bordering Afghanistan and Iran.
The private sector, as well as domestic households, is looking at the government to pass on benefits of lower oil prices. There are sufficient compelling reasons for this, as it would benefit the domestic economy.
According to a recent survey by The Economist, countries that have enjoyed strong GDP growth last year are the ones importing oil. On the other hand, economies that are producers and exporters of oil such as Saudi Arabia, Russia, Brazil and Nigeria are under severe strain.
Saudi Arabia is contemplating selling 10% of shares in Aramco, one of the most valuable companies in the world, as well as cutting expenditure. Russia has already announced a 10% reduction in public spending.
The plunge in oil prices is an opportunity for Pakistan to boost the domestic economy by passing the benefit on to the end-consumers. It would improve competitiveness of the industry and increase consumer welfare, which would have lasting benefits. In the short term, the loss of revenue will be the price worth paying.
The writer is a development professional with over 20 years of experience in public and development sectors
Published in The Express Tribune, February 1st, 2016.