Global Oil Price Shocks: determinant of Inflation and deteriorating Foreign Reserves | MG Opinion

November 23, 2018 (MLN):  In the past, oil price shocks have raised serious concerns among the policy makers around the world, because of its adverse impact on the developing economies.

Throughout the 21st century, the dynamics of oil prices have been among the most followed trends in the world economy.

During the years 2003 -2008, unprecedented increases in oil prices, mainly caused by a boom in demand and stagnation of production were observed.

Demand, supply and speculative factors, and their interrelationships all led to the steady rise in oil prices.

Pakistan is an oil-importing country. An increase in oil price leads to inflation and an increased budget deficit within the country, as well as it puts a downward pressure on the exchange rate which makes imports more expensive.

Historically, Pakistan has remained a net importer of crude oil and petroleum products. The rising trend in international oil prices erodes country’s paltry foreign exchange reserves.

Any variation in the oil prices brings a rapid change in all others macroeconomic variables of a country.

Historically, oil price swings and inflation have been positively correlated, even though this relationship has varied widely across countries.

Large increases in oil prices during the past 40 years were followed by episodes of high inflation, increased budget deficit and put downward pressure on exchange rate which made imports more expensive and reduced economic growth in Pakistan.

Huge rise in world oil price shifted the burden to the consumers as government is already running severe losses and equally shifted this burden to households.

Source: OPEC, International Financial Statistics and State Bank of Pakistan

A closer look at the graph indicates that over the period from 2003 to 2017, when the global crude oil price fluctuates, their impact reflects in the figure of CPI and official exchange rate. Figure shows a close relationship between global oil prices and inflation in the economy.

As percent change in global oil price rises, inflation simultaneously rises with increasing rate whereas, as percent change in global oil price decreases, inflation increases at a slower rate than before. The increase in inflation puts downward pressure on exchange rate.

The trend indicates that currency depreciates with higher rate as inflation rises with increasing rate and vice versa when inflation rises with decreasing rate.

During the period 2012 to 2016, oil prices declined sharply following which, inflation increased at a slower rate than before.

During the previous year i.e. 2017, global oil price again picked up a hike which resulted in a rise in inflation and therefore, currency devalued further.

Sharp rise in oil prices is not a good sign for the development of any country as it ultimately leads to other economic diseases like inflation, unemployment, poverty, industrial devastation and destruction of social sector.

Oil WTI Price Trend during the Current Year (US$/ barrel)

During the current year, oil prices experienced an increasing trend until the month of  October 2018, after which oil price decreased sharply and reached to 53.40 US$/ barrel by November 20, 2018.

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.

Pakistan should cash this opportunity for saving up money and boosting economic growth.

However, from the government’s perspective, the fall in global oil price acts as a threat to its revenue as the government is heavily reliant on taxes on imports to generate its revenue.

According to SBP, during FY2017 from July to April, around 55% of total sales tax was collected from the sales tax on import.

In the short-run, government has the policy option to increase import tariffs, to raise its revenue.

As Saudi has indicated to cut down its oil production to control oil prices, uncertainty has returned to the markets, that oil prices might rebound in future.

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Posted on: 2018-11-23T15:50:00+05:00