Effect of Rising Oil Prices on Trade Balance of Pakistan free essay sample

An increase in oil prices result in increased oil imports bill because its demand is inelastic which leads to inflation, increase budget deficit and puts downward pressure on exchange rate which makes imports more expensive increases the industry production cost which affect its competitiveness in international markets. INTRODUCTION: With the advent of industrialization in the last century the use of petroleum products as the main energy input for all the industries, international crude oil prices has become the key indicator of economic activity. Although other forms of energy (hydro, natural gas, coal etc) are also in use in Pakistan but still imported oil energy covers a major portion. So therefore any change in international crude oil prices cause to affect all the sectors of the Pakistan economy including the welfare of the society. WTI and Brent are considered the key benchmark for international crude oil prices. Since 2001 oil prices are showing an upward trend reached all time high level in July 2008 to the value of 8 per barrel. Before we consider the effect of rising fuel prices on Pakistan trade balance, an important much related issue is that all the transaction in world crude oil markets are conducted in US dollars foreign exchange reserves of Pakistan which are used to finance international transactions like other imports, debt repayments etc are also kept in US dollars. Hence an increase in oil import bill tends to put considerable influence on the market value of Rupee in the currency market in case of any imbalance in current account. Pakistan also produces oil domestically but its production is much less than its local demand so therefore Pakistan needs to import oil from other countries. Historical data shows that an increase in international crude oil prices has an adverse impact on our current account balance simultaneously affects our exports by increasing the domestic cost of production. The net result is widening of trade deficit, higher inflation depletion of valuable foreign exchange reserves which are vital for the stable rupee exchange rate. REVIEW OF LITERATURE: In this section we will review the articles and research work related to our topic. Joao Ricardo (2009) analyzes the impacts of oil prices with reference to china’s exports. The result of his study suggests a stable long run association between oil prices export earning incase of china. He used the quarterly data for the period of 1975 to 2002 in his study find out a negative relationship between coefficient of export earning oil prices volatility. Hamilton is the pioneer towards the oil prices issue on economy. He carried out a number of studies related to oil prices . His studies shows that there is significant relationship among oil prices volatility, economic growth development inflation in industrial countries. Suleiman d. Mohammad (2009) analyzes the impact of oil prices volatility export earning with reference to Pakistan . His study suggest a significant correlation among export earning oil prices. He used the annual data for the period of 1975 2008. Salim (2007) reviewed that the government reviews fuel prices every two weeks, but despite increasing in global oil prices, fuel prices were not heighten in the country during the last 19 months to save the public from additional financial burden. According to caretaker Finance Minister Dr. Salman Shah, the fuel prices adjustment will not be done in one go. We will be increasing prices gradually. He said the fuel prices were being adjusted according to budgetary targets. â€Å"We have to keep in mind many things our targets, the state of the economy and the inflationary impact†. Reigner (2007) study focuses on commodity prices for the period of 1945 to2005 in case of United States he find out that the 91% of prices of goods sold in U. S were affected by oil prices. ANALYSIS: From 1989 Pakistan trade deficit is showing a rising trend but at a very slower rate. It showed improving trend for only a short period of time i. e. between the years 1999- 2003. After that Pakistan trade deficit increased at a very high annual rate reached 20 billion us dollars in 2008. After 2008 Pakistan trade balance has shown improving trend mainly due to global recession lower oil prices. [pic] EFFECT ON TOTAL IMPORTS: Economic Survey of Pakistan 2008-09 shows that current population of Pakistan is 170 million and 6th largest populated country of the world on the other hand Pakistan is the lowest consumer of the energy (around 0. 50 TOE/capita). Due to the shortage of energy Pakistan depends upon imported energy resources. [pic] PAKISTAN TOTAL EXPORTS IMPORTS OIL IMPORTS: | | | | |us million $ | |YEAR |EXPORTS |IMPORTS |DEFICIT |oil imports |% of imports | |1985 |2491 |$5,906 |-3415 |$1,086 |18% | |1986 |3070 |$5,634 |-2564 |$921 |16% | |1987 |3686 |$5,380 |-1694 |$935 |17% | |1988 |4455 |$6,391 |-1936 |$1,020 |16% | |1989 |4661 |$7,034 |-2373 |$1,279 |18% | |1990 |4954 |$6,935 |-1981 |$1,522 |22% | |1991 |6131 |$7,619 |-1488 |$1,516 |20% | |1992 |6904 |$9,252 |-2348 |$1,377 |15% | |1993 |6813 |$9,941 |-3128 |$1,578 |16% | |1994 |6803 |$8,564 |-1761 |$1,450 |17% | |1995 |8137 |$10,394 |-2257 |$1,722 |17% | |1996 |8707 |$11,805 |-3098 |$2,010 |17% | |1997 |8320 |$11,894 |-3574 |$2,246 |19% | |1998 |8628 |$10,118 |-1490 |$1,750 |17% | |1999 |7779 |$9,432 |-1653 |$1,485 16% | |2000 |8569 |$10,309 |-1740 |$2,783 |27% | |2001 |9202 |$10,729 |-1527 |$3,327 |31% | |2002 |9135 |$10,340 |-1205 |$2,664 |26% | |2003 |11160 |$12,220 |-1060 |$3,098 |25% | |2004 |12313 |$15,592 |-3279 |$2,264 |15% | |2005 |14391 |$20,598 |-6207 |$3,550 |17% | |2006 |16451 |$28,581 |-12130 |$5,956 |21% | |2007 |16976 |$30,540 |-13564 |$7,346 |24% | |2008 |19052 |$39,966 |-20914 |$10,496 |26% | |2009 |17688 |$34,822 |-17134 |$10,032 |29% | |2010 |19290 |$34,710 |-15420 |$10,463 |30% | As we can see from the data oil imports graph that our trade deficit between the year 1985-2002 was stagnant around 6 to 8 us billion US$ due to stable international oil prices Our import bill was also just around 1-2 billion dollars . The upward trend of oil prices from 2001 contribut ed greatly to our rising trade deficit. In past its shared only 15-18% of our total imports but in 2010 it covers 30 % of our total imports. Our oil import bill reached record level of 10 billion $ in 2008 due to very high international oil prices. EXPORT EARNING: Although there are many other factors that affect our exports that include political stability, law order situation, governance, economic policy etc but rising oil prices that leads to domestic inflation is also a major factor in it. Power transport prices play an important role in determining the prices of all the industrial sector output. They represent approximately 30% of the cost in the cost of making any industrial commodity. So when transport power prices increases, industry profit margin decreases they have no option except to increase the final good prices, which adversely affect their market competitiveness. As we can see from the pie chart below that our power transport sectors are dependent upon oil which directly affects their prices when the international oil prices increases. In the year 2009-10 transport power sectors were the major consumer of imported oil. These two sectors combindly consumed around 92% of oil imports. While all the other sectors combined consumption was just around 8% of the total oil consumption. When fuel prices rise, commodities and other goods inside the Pakistan become more expensive. With higher fuel prices, it becomes more expensive to manufacture and transport goods. The increase in costs to produce and transport the goods must be factored into a higher price for the products. Pakistan sales of the products affected and particularly volume of Pakistani exports may decline as a result of the higher prices that manufacturer must now charge for their goods. [pic] [pic] Last 10 years CPI data of energy power prices shows a drastic increase in their prices. Their prices have more than double in this period. Despite this drastic price increase, oil consumption has not reduced accordingly. The reason for this is that demand for oil is inelastic in the short term due to absence of substitute fuel. To help explain this inelastic demand, consider the following: Truckers are still expected to haul, and commuters must continue to commute. If fuel prices go up, our economy doesn’t just stop. People still have to go to work. The result of an inelastic demand for Oil is that people will continue to buy and pay more for the fuel (because they have no Immediate alternatives), but will change their spending behavior elsewhere because of their fixed amount of income. Now we are analyzing the empirical effect of oil prices on Pakistan exports with help of an econometric model. Model Log Export earning = ? 1+ ? 2log GDP + ? 3 log M2 + ? 4 log GINI + ? 5 oil price + ? 6 log BOT + e The above model shows that the export earning is dependent variables and GDP, M2, GINI, oil prices are independent variables. Hence GDP stands for Gross domestic product, M2 is a monetary aggregate and GINI is a coefficient which measures the living standard and allocation of wealth in an economy. BOT shows the balance of trade (Export-Import). All the variables are taken in natural log form which shows the elasticity and the percentage change in independent variables causes how much changes take place in dependent variables. |   |log GDP |log GINI |log BOT |log M2 |log Oil prices | |Coefficient |0. 4587 |5878 |1. 2124 |0. 7824 |-1. 5987 | |t values |2. 125 |3. 214 |4. 2567 |2. 1458 |5. 2133 | The result of model shows that there is long run association among the variables. Coefficient of GDP is significant and positive sign shows that as GDP increases then output level increases and cause to increase in export earning but coefficient is in elastic in sense that as 1 percent increa se in GDP Cause only 0. 45 percent increase in export earning. The coefficient of BOT (balance of trade) is also positive sign and significant as our balance of trade improve it may positively affect on export earning of Pakistan. The coefficient of GINI is used to analysis the affects of export earning at living standard of the society. It is also significant and positive shows that 1 percent increase in GINI coefficient cause to increase in 0. 59 percent increase in export earning. The sign of M2 is also positive and significant as M2 increases interest rate declines cause real depreciation of local currency and increase in export and reduce the import and positive affects on export earning of Pakistan. Finally the coefficient of oil price is negative and significant the coefficient of oil price shows highly elastic 1 percent increase in oil price may cause to 1. percent reduce in export earning which is a suggestion for policy makers if they continue to import crude oil and no substitution is found locally then it may adversely affect Pakista n economy in future Conclusion: In this paper we have studied the effects of rising oil prices on Pakistan trade balance. Although Pakistan is heavily relying on domestic natural gas resources but still oil contribute 32% to our energy needs oil imports covers 30% of our total imports. We also conclude that oil prices have negative relationship with the export earning of Pakistan it may adversely affect our exports growth rate. To ensure the sustained improvement in Pakistan trade balance Pakistan needs to further diversify its energy mix. So that Pakistan can end its dependence on imported energy. Our dependence on imported oil needs policy maker’s immediate attention because it is drastically affecting our economic growth trade balance. This dependence on oil can be reversed or at least minimized in just 1-2 years if we only had proper leadership in parliament senate. If the Parliament had taken steps to make national energy transport policy to use only domestic resources, then there would have been no such problems that Pakistan economy is facing today. Recommendations: Short term: Pakistan dependence on imported energy can not be eliminated in few months but with proper policy making in few years it can be achieved. Firstly our parliament should make a policy of energy independence, i. e. reliance on our domestic resources only for all the energy needs. God has given the Pakistan 6th largest coal reserves in sindh. They were discovered in 1991 but even after 20 years we are not able to use them. All over the world coal is used for electricity generation to get cheap energy. Like them Pakistan can also use coal for electricity generation by converting its thermal power plants from furnace oil gas to coal in short run. For transportation a new policy making is also necessary because it is mostly provided by private sector for long short routes both they are relying heavily on oil gas. All over the world railway plays a major role in land transportation because it’s cheap fast. Electric railway engines are used to further reduce the cost of transportation oil dependence. But Pakistan railway today has a very small share in cargo transportation because of bad governance road transport mafia. Under new Policy best management should be placed in railways the policy should be made that all the cargo for long distances would be transported only by Pakistan railways. These two policy action if taken will dramatically reduce our dependence on oil in short run. Lastly taxation policy on petroleum products should also be reviewed which is contributing to high inflation rate in the Pakistan. Long term : Use of fossil fuel will continue to satisfy majority of Pakistan energy needs in the next decade also but they pose a number of problems one is the concern over the public health and environmental effects of fossil fuel–based energy production and its use. In particular, the emission of many common air pollutants that are created by the combustion of fossil fuels increases the risk of premature mortality and numerous acute and chronic health conditions. Additionally, these emissions damage ecosystems, impair visibility, and have a substantial impact on water and soil quality. Secondly their supply is fixed after few decades they get deplete. Use of Renewable Energy Resources There are many alternatives to fossil fuels available for meeting our energy needs in the electricity, transportation, and other sectors. Electricity may be generated using renewable sources (such as wind, solar, geothermal, biomass, and hydropower) or nuclear power. In the transportation sector, solutions range from finding new fuels for traditionally gas-powered vehicles to those that run on electricity or hydrogen. Renewable sources of energy such as wind, solar, and geothermal power are desirable for generating electricity because, despite their high initial fixed costs, they are domestic sources of power with no fuel costs or emissions except those involved in building the infrastructure required to generate the power. Biomass-fired electricity, which is derived from sources such as wood, waste, and alcohol fuels, is also a renewable source. References: Pakistan Energy Yearbook,† Hydrocarbon Development Institute of Pakistan †¢ International Energy Agency (sep 2010) Analysis of the Impact of High Oil Prices on the Global Ec †¢ Ishrat Hussain, (2008)Pakistan Exports competitiveness in Global †¢ Ishaque, Fozia (2008), â€Å"Oil Prices Hike; Pakistan Facing the Music† Pakistan and Gulf Economist, Dec3-9, 2007. †¢ www. finance. gov. pk – for data on Pakistan trade balance energy transport sector †¢ www. mpnr. gov. pk for data on petroleum products. †¢ www. imf. org for international oil prices data †¢ Economic survey of Pakistan 2009-10 †¢ Khan, Mehmood-ul-Hassan (2008) Negative Aspects of Macro-economy. Business Finance Review, the News, Monday February 4, 2008. Power, 46. 1% 46. 3% Transport, Other govt. 1. 7% Domestic, 0. 5% 0. 3% Agriculture, Industrial, 5. 1% Oil Consumption by sector (2010)