Subsidising oil prices

Despite a virtual cacophony of voices opposing its move, the government has decided to bow to the pressures of political expediency and continue its subsidy on fuel prices. The government is under enormous strain from its coalition allies. It is never easy to raise prices, especially in an already high-inflation environment. Yet the administration must understand that a failure to curb subsidies is likely to lead to an unsustainable widening of the federal budget deficit. In essence, the current policy of the government is a repeat of what the Musharraf administration tried in 2007. The result was a gigantic inter-corporate circular debt, which has crippled the energy sector, and high inflation. Clearly, this policy should not be repeated.

Of course, lest this newspaper be accused of advocating higher petrol prices, it should be clarified, that the subsidy created by the government to keep the price unchanged would necessarily lead to inflationary pressures. This would happen because the subsidy has to be funded by either tax collection or other revenue such as a loan or aid inflow. In Pakistan’s case, the usual route is borrowing from the State Bank, which in other words means printing more money, and that causes inflation. Furthermore, the budget deficit, which is already on its way to being well beyond its IMF-stipulated limit of 4.7 per cent of GDP, could reach as high as seven or eight per cent. The finance minister has recently commented on this, saying that such a high level would be unsustainable for the economy and that cuts in government expenditure would have to be made somewhere. If the oil subsidy is not brought down, then such cuts would have to be made in the public sector development programme and spending on social and human development would suffer.

Published in The Express Tribune, February 2^nd, 2011.