Saudi oil facility and foreign exchange

Saudi oil facility will ease miseries through single-digit inflation, boost business confidence, provide fiscal space.

Fahd Rehman February 19, 2014
The writer affiliates with the University of New South Wales Canberra, Australia

The ongoing global uncertainty and tension in the Middle East are fuelling speculations in the international crude oil markets since 2007. The annual average crude oil prices have moved up from $64 a barrel in 2007 to $90 a barrel in 2013. With the Saudi crown prince having visited Pakistan in the middle of February, this being the second visit of a Saudi official after the Saudi foreign minister’s visit to Pakistan last month, the timing is right to ask for the Saudi oil facility to defer payments for the next two years. Keeping in view the current economic circumstances and depleting foreign exchange reserves of $8 billion, Islamabad should request for this facility, since the evidence suggests that economic and political gains out of this would be greater on the following grounds.

First, the import bill for crude oil and petroleum products have increased from $7.3 billion in 2007 to $14.9 billion in 2013, despite lower economic growth in Pakistan. As a result, imported petroleum products to merchandise imports percentage has increased from 24 per cent in 2007 to 35.5 per cent in 2013. These higher oil prices are putting a further drag on the exchequer through higher current expenditure and an increasing fiscal deficit; hence, the current account deficit. The facility — to a great deal — will help in reducing the import bill for petroleum products.

Second, the economy of Pakistan is in the grip of double-digit inflation since 2008, with a pause in 2013. These higher international oil prices are translated into higher domestic petroleum prices. The domestic petroleum prices are fuelling inflation, specifically in food items, which persists in double digits. Moreover, the public policy failure of successive regimes has shifted the energy mix radically in favour of thermal means since the 1990s. At present, the production of electricity is mainly done through thermal energy, which contributes around 60 per cent, while the hydroelectric share is around 38 per cent. The heavy reliance of Pakistan on imported furnace oil not only puts a strain on the foreign exchange reserves owing to high international crude oil prices, but also contributes heavily to circular debt. When international oil prices cross $100 a barrel, electricity load-shedding increases from four to 10 hours, since the government does not want to increase its fiscal and current account deficits. The higher oil prices should not further translate into higher electricity tariff, since it fuels inflation. The double-digit inflation entails a huge political and social cost, which Islamabad should take into account while making public policy decisions.

Third, the regime in Islamabad has already opted for the Extended Fund Facility (EFF) programme of the IMF. It is bound to meet a long list of fiscal, monetary and financial reforms, and has requested the IMF in the first quarterly review for a waiver of nonobservance of performance criterion and its modification. Specifically, it is facing a problem to meet the net international reserve target along with current account deficit due to higher oil prices. The attainment of the Saudi facility will help to meet these targets easily without asking for further waivers.

The Saudi oil facility will ease the miseries of masses through single-digit inflation, boost business confidence, and provide fiscal space to Islamabad to pursue its mega developmental objectives and jack up foreign exchange reserves. The economic gains out of this facility would be even stronger than launching the Euro Bonds, privatisation of public sector enterprises, and seeking international commercial loans. Does Islamabad have the ability to do this? The answer is yes.

Published in The Express Tribune, February 20th, 2014.

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COMMENTS (11)

SHB | 6 years ago | Reply | Recommend

In stead of begging other countries, first we must control our spending in the budget. Tax the rich people of the country. Give me names of first one hundred people of the country who were forced to pay the taxes. Catch those people who are stealing electricity. Not only these people should be behind the bar, one should confiscate their assets also. Once you have put your house in order, then you can evaluate, do you still need this oil facility from Saudi Arabia?

be told | 6 years ago | Reply | Recommend

A credit facility will save our neck for the time being. But in the long term that loan will have to be paid back with interest so it will cost us more. Yes, even the Islamic Saudis expect interest on loans.

It also doesn't solve the core problem which is that the rupee is overvalued and needs to be allowed to depreciate. If the currency is allowed to float freely we won't have any problem meeting our foreign exchange needs. It is when you try to control the currency that you only create problems for yourself. Yes, a falling rupee will cause inflation. But propping up the rupee by taking forex loans will only cause more depreciation in the future when those loans + interest become due.

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