Brewing oil crisis: what should be our policy response?

SOURCEBusiness Recorder

The enormity of the attacks on Saudi Arabia’s oil installations could be gauged from two key facts: a) according to Bloomberg, ‘Brent futures rising 19% in the matter of seconds at the open on Monday [September 16- the first day the markets opened after the attacks] and ending the day up 15%, their single biggest-day advance’, and b) as per International Energy Agency (IEA) and indicated by Bloomberg, ‘the disruption surpasses the loss of Kuwaiti and Iraqi petroleum output in August 1990, when Saddam Hussein invaded his neighbour. It also exceeds the loss of Iranian oil production in 1979 during the Islamic revolution’.

Although since then around half of the lost output has been restored by Saudi Arabia, and the country expected to return to pre-strike processing levels by the end of the month; yet this may be an over-estimation since progress of built-up is slower than initially thought, resulting in crude prices still remaining elevated as risks remain. Among these risks is the likely heightening of Middle East tensions given that both the United States and Saudi Arabia see a strong hand of Iran behind these attacks. Here, although Houthi rebels – considered by the two countries to be backed by Iran -have taken responsibility, both Saudi Arabia and the US remain persistent that there is greater direct involvement of Iran behind these attacks.

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Moreover, there may be a case of an oil crisis brewing, since this attack is among a string of happenings related with oil, for some months now. Coupled with it is the rising of related Middle East tensions, the likelihood being that this will not be the last happening in this regard, is quite significant.

Even as Saudi confidence is injecting some hope into oil futures market, yet the above risks and the large scale of disruption itself, including the lack of capacity in stockpiles by the kingdom domestically and abroad, to cover all the grades of crude oil lost, and also as to how much and if at all the US will supply from its stockpiles of oil, also affects recovery. Also, a geopolitical analyst, Richard Mallinson of the Energy Aspects Ltd in London, indicates, ‘If you take 50% of the lost output and bring it back online, you’re still left with an absolutely huge disruption that might continue for some time longer.’

Here, one is also reminded of the phenomenal rise in prices during the global oil crisis of 1973, when in a matter of few weeks the price of an oil barrel increased from US$2 to US$11, which gave coinage to the whole of issue of ‘stagflation’, where stagnation (in economic growth) and inflation occur simultaneously. In particular, the countries that are a net-importer of oil, including Pakistan, are all the more affected by positive spikes in oil prices. For them the brewing oil crisis should serve as a strong alarm for all their policy stakeholders.

In Pakistan, the current economic situation being indicative of one where the country is grappling with the twin-deficit issue, and is in an IMF (International Monetary Fund) stabilisation programme, the oil price instability and the whole risks attached (discussed above) constitute an even bigger challenge than that for the stronger economies such as Japan, China and India, the major importers of oil from Saudi Arabia.

The economic growth is already reeling in Pakistan, especially on account of huge devaluation of exchange rate against the US dollar and the State Bank of Pakistan’s (SBP’s) policy of drastically increasing the policy rate for many months now, and still retaining it at 13.25% in its Monetary Policy Statement announced this Monday, September 16 after the strikes on oil fields taking place on Saturday! The positive oil price shock and the rise in Brent crude futures from time to time at the back of Middle East tensions seem to have been missed by SBP, in terms of their difficult consequences for Pakistan’s economy, for some time now.

Moreover, globally, there is a general trend of adopting a relatively loose monetary stance, and give more space to fiscal policy; especially at the back of understanding the limits of monetary policy in tackling issues of stagnation and inflation. Also, there is strong evidence now that Phillips Curve’s negative relationship between inflation and unemployment does not hold as such in general for some time now, and that there is a weak negative relationship, if at all, between policy rate and inflation in developing countries like Pakistan, where inflation is at least equally a fiscal phenomenon.

The other stakeholder of the economy, the Ministry of Finance, has not taken any step to substantially reduce the component of indirect taxes/levies/margins in the overall price of landed oil. They are also hiding behind the non-elected SBP, and not putting their pressure either towards calling for a reduction in policy rate, along with and some meaningful reduction in depreciation of the rupee against the US dollar.

Isn’t ultimately, it is the responsibility of the government to bring needed policy, including asking the SBP and the IMF to shift their goal-posts and the underlying (over) reliance on the two policy instruments, to lower the negative impact of this oil price hike on domestic production and overall already low economic growth rate especially when the SBP and the IMF have not cared enough to give proper importance to the consequences of brewing oil crisis for some time now feeding, among other governance related issues, into rising inflation and a significant slowdown in economic activity as a result of both programme preconditions and its highly imbalanced aggregate demand squeezing conditionalities?

Being a partner in setting the economic agenda through the bargaining power it holds as a lender, the IMF and its director for this region, who is visiting Pakistan currently, showed a serious lack of insightful attitude, at least reportedly, when in response to the brewing oil crisis and its likely impact on the already net-importer of oil Pakistan, and which is already severely grappling with its lower export potential and overall BoP (balance of payments) issues, he gave a very general and broad-brush kind of a response with no specific policy guidelines for Pakistan in terms of the role of policy instruments under the current IMF programme; and in this regard, I quote Wednesday’s (September 18) Business Recorder, he said ‘volatility of oil prices is an issue that would affect the countries of the region and to address the issue of volatility of prices, the Fund has certain number of recommendations for oil importing countries to reduce their dependence on oil.’

The IMF should learn from multiple programme country experiences, and realize that it needs to balance its programmes in terms of squeezing-less aggregate demand and boosting-more aggregate supply; especially in countries like Pakistan suffering from the issue of stagflation.

Are the stakeholders not cognizant that the economy is already slowing down at the back of high policy rate, devalued exchange rate and lack of fiscal stimulus all feeding into keeping high the cost of capital, greater upward pressure on the already high electricity tariffs – where around 40% of electricity production is fuel-based – and the imported inflation component, for example, through the channel of imported oil and machinery for capital investments and in turn, keeping the cost of production on the higher side?

Although the current account has narrowed down, it is not sustainable in the wake of brewing oil crisis, the low level of exports and slow economic growth at the back of slowdown in economy.

Urgency of reforms

That slowdown owes to poor reform strategy to come up with institutional reforms to reduce losses in the state-owned enterprises in particular. It also owes to the retarding of economic activity at the back of a squeeze – through over-reliance on the two policy instruments – put on producers’ capacity to invest, import machinery, meet oil and electricity costs, and remain competitive.

Also, the current oil crisis if not met with a revisit to the IMF-MoF-SBP hawkish use of policy instruments, will not only exacerbate stagflation, and allow BoP issues to bounce back vociferously, but will also reduce ability of organizations in the energy sector to catch up with payments to each other in a way to undo the circular/revolving debt crisis. That would also lead to greater bailouts through national exchequer, since in the current IMF programme there are limits of circular debt, and the addition will be paid by government so that these limits are adhered to.

This does not know whether the IMF still feels comfortable with its reported expectation that the current programme is going in the right direction and no revisit is needed. Should the government also go along with this view? And will the opposition also not present a meaningful plan to enable the country in meeting these grave economic challenges?

(The writer holds PhD in Economics degree from the University of Barcelona, and previously worked at International Monetary Fund. He tweets @omerjaved7)

(This news/article originally appeared in Business Recorder on September 20th, 2019)

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