Jun 172008

 Pakistanis have been particularly vociferous in holding the government accountable for the oil price rise in recent months. Not surprisingly, the politicians have been embroiled in a blame game made all the more credible because of the fact that the country has been subjected to three different administrations during the past eight to ten months.

Throw in a general election considered to be largely fair and free, and one has all the ingredients necessary to make accusations stick. The budget for the fiscal year 2006-07, prepared by the Shaukat Aiz government, failed to take any account of the possibility of a rise in the international price of oil. In today’s world of hedge fund managers such failure cannot be explained away by blaming external factors, as Musharraf and his band of dwindling cohorts would have us believe.

And the people of this country are paying the price of this failure which was compounded by three decisions forced onto the newly elected government: (i) because of the impending elections the caretaker government took the decision to continue to subsidise oil prices in the domestic market, which, in turn, put pressure on the government to (ii) slash expenditure with, as usual the Public Sector Development Programme (PSDP) being the casualty; and as this was not adequate, (iii) heavier reliance was placed on deficit financing or borrowing from the banking sector – a highly inflationary policy. Thus even though the oil prices were artificially stabilised, the inflationary pressures increased mainly because of a higher deficit.

This accounted for a 9.5 percent estimate of budget deficit according to the PML (N)’s short term Finance Minister, Ishaq Dar – scaled down to 7.5 percent on the assumption that the proposed reduction in PSDP would take place. Actual figure released by the Economic Survey was 7 percent.

There is no question about the fact that the ability of a large number of Pakistani households to make ends meet is being eroded due to inflationary pressures. However, the question that comes to mind is the policy of subsidy is something that is sustainable? Classic economic theory gives subsidies as a policy option an overwhelming thumbs’ down: an across the board subsidy implies a distortion of the market which will have to be paid for by the government.

In the case of Pakistan’s oil subsidy the government has had to pay out huge sums of money from its scarce resources, leading to high budget deficit. If the subsidy is targeted then the issue of abuse in a country like Pakistan where governance remains a challenge crops up almost immediately.

That words do change in meaning over time is a study in itself. However, as an example, the word sophisticated is rooted in the word sophistry which, in times of yore, meant false. Today the word sophisticated has no negative connotations. A look back at history reveals that the word ‘subsidy’ was originally envisaged as a progressive tax, a precursor to the modern day income tax, and was first levied by Thomas Wolsey in 1513 with the objective of raising money to pay for Henry VIII’s war with France.

Today subsidy is defined as state support for its poor, or state support targeted to certain industries/farmers/interest groups belonging to segments that are not poor by any stretch of the imagination. An example that comes to mind is the textile sector, another the rich absentee landlords sitting in our national and provincial assemblies; even our armed forces have received many an economic incentive in its non-defence related production activities.

With the rise in the international oil price its impact, therefore, is not limited to Pakistani consumers. Strikes and protests are becoming widespread in Western countries, from the UK to France to other European Union countries. And the 27 EU countries are at odds over what is the best way to deal with the crisis. Acting sanctimoniously they have rejected demands for a subsidy – this is after all against classical economic theory. However such economic considerations do not apply to the EU’s farm policy that heavily subsidises the farm sector – a subsidy whose benefits are not passed onto the EU consumer. Politics, as always, plays a bigger role than economics.

The Iranian President Ahmedinejad has stated that oil prices have been artificially inflated by ‘capitalists’ and that crude oil remains plentiful: “while the growth of consumption is lower than that of production and the market is full of oil, prices are constantly on the rise and this situation is completely artificial and imposed…Powerful and international capitalists (are working) mendaciously to pursue their political and economic aims.” Critics disagree.

They cite the latest figures from US government agencies and trading data that indicate that hedge fund managers and speculators have reduced bets on higher oil prices by 80 percent since July last year when prices began to rise sharply and crude futures rose to record highs. So if it’s not the hedge fund managers and the speculators, then who is responsible for the oil price hike?

Could it be the massive liquidity in the financial markets that accounts for oil price rise? Mr Ito, senior analyst at UBS Securities Japan, agrees: “Oil prices are surging not because of a supply shortage, but because of massive liquidity,” he maintained referring to the influx of financial funds into markets, helped by low interest rates.

Or could it be the oil companies that are responsible for the oil price hike? Democrat Senators in the US want to levy a windfall profits tax against the five largest U.S. oil companies and rescind $17 billion in tax breaks the companies expect to enjoy over the next decade. “The oil companies need to know that there is a limit on how much profit they can take in this economy,” said Sen. Richard Durbin of Illinois, the Senate’s No 2 Democrat, warning that if energy prices are not reined in “we’re going to find ourselves in a deep recession.” But the Democrats are going to have to overcome staunch Republican opposition to any new taxes on the oil industry. The five largest US oil companies earned $36 billion during the first three months of the year.

Given the problem the question is: what is the best solution? French President Nicolas Sarkozy has called for an EU-wide cap on value-added taxes on fuel. VAT accounts for some 70% of prices at the pump in much of Europe and according to Sarkozy, the French government is earning an additional €150-170 million in VAT receipts every three months as a result of the explosion in oil prices. This money could be used to offset the worst impact of the fuel price rises, he said. His proposals have already been met with widespread skepticism from the Commission and other European governments.

Amelia Torres, a spokeswoman for Joaquin Almunia, the EU commissioner for monetary affairs, said that tax cuts would send the wrong signal to oil-producing countries that European states were willing to absorb rising gas prices. But at the G-8 summit in Amori, Japan, plus 3 (including the three major oil guzzlers of the world namely China, India and South Korea) it was decided to focus on the consumer nations: technology, conservation and diversification. This has raised other concerns: technology may be at odds.

It is not yet clear what action the EU will take: reduce taxes or hope that the price of oil will eventually come down. But it is clear what Pakistan will do: Seek a Special Oil Facility which will defer payment for imports by one year at least. And what will happen a year from now, critics may ask? Who knows what tomorrow will bring is a refrain that will, in all probability, gather momentum as helplessness may well overtake the average consumer burdened under inflationary pressures. Surprisingly it is not even clear what action the government of Pakistan will take in spite of the fact that the budget has been announced.

According to the budget documents subsidies related to oil and electricity sector are as follows: (i) WAPDA to receive a subsidy of 74,612 million rupees (lower than the revised estimated for 2007-08 of 113,658 million rupees) with the major share to be allocated to inter-Disco tariff differential estimated at 65,000 million rupees for 2008-09 as opposed to 87,000 million rupees for the revised estimates for this year. (ii) KESC is to receive 13,800 million rupees with 12,000 million rupees to be allocated to KESC on account of tariff differential in contrast to last year’s revised estimates of 19,596 million rupees and 15,796 million rupees respectively. (iii) The budget document states that 15 billion rupees was budgeted last year to be paid on account of price differential claims of POL products, however a total of 175 billion rupees only was paid due to political constraints – this figure will be reduced to 140 billion rupees in the forthcoming fiscal year.

It is not clear what this figure reflects in terms of whether the government believes it will receive the Saudi Oil Facility or the rupee-dollar parity which would determine the extent or limit of the subsidy. In short there is confusion and the people will have to wait for what the next year will bring in terms of cost of oil and products as well as the cost of electricity.

Source: Business Recorder, 17/6/2008

 Posted by at 11:21 am

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