Well done, prime minister

An unfortunate reality in Pakistan is that some key economic decisions are made without considering their impact on resource allocation or, put more simply, by realising their full distributional consequences. One such decision is the setting of the petroleum prices on a monthly basis.

Needless to say, this is perhaps the most important set of prices that affect the full spectrum of economic activities. Yet, it is not infrequent that this key decision is often mired by considerations other than simple economics.

The recent decision of the prime minister to pass on the increased prices to consumers is a breath of fresh air in an otherwise suffocating paralysis in economic decision-making. We would encourage him to take more such actions to steer the drifting ship of the economy.

The system of setting petroleum prices is fairly straightforward. In this article, we will explain it for the two main products – motor spirit or petrol (MS) and high-speed diesel (HSD). (In a separate note, we will delve into the rationale for this in each individual item).

The process starts with the ex-refinery price, which is (in view of major imports) essentially the import price determined from the Arab Gulf Market Average of imports made by PSO during the month. For November, the ex-refinery price of MS was Rs44.12 per litre and HSD Rs44.60 per litre.

At the import stage, there is an (effective) excise/customs duty of 4 percent on MS (Rs1.79) and 12 percent (Rs5.47) on HSD. However, the local refineries benefit from this protection as they face the same price as imported products.

To this, three additional costs are added: inland freight (MS: Rs3.14; HSD: Rs1.42) distributor’s margin (MS: Rs2.55; HSD: Rs2.41) and dealer’s margin (MS: Rs3.35; HSD: Rs2.67).

Then there are local taxes. First, there is the petroleum levy of Rs10 for MS and Rs8 for HSD. Second, after adding the levy, the resulting price is charged a sales tax at the rate of 17 percent for MS (Rs11.02) and 31 percent for HSD (Rs20.02). The consumer price is arrived at after adding the sales tax. The final price of MS is Rs75.99 while the price for HSD is Rs84.59. The share of taxes in the final price is 30 percent for MS and 40 percent for HSD.

Evidently, when prices are rising, the government has a degree of freedom to not pass them on roughly to the extent of 30 percent and 40 percent of the present prices of MS and HSD, respectively. Beyond this, a cash subsidy will have to be provided. On the other hand, when prices are declining, the government may leave prices unchanged and mop up the savings in extra revenues. This is where the government has the power to play with the petroleum prices.

Taxes on petroleum prices are the most significant source of revenues, even in the rich OECD countries where the share of taxes is mostly in excess of 50 percent of the sale price. In Pakistan, nearly one-third of the revenues are derived from the oil and gas sector, including almost half of the GST at the domestic level and 30 percent at the import stage. Accordingly, variation in taxation during the year would have major consequences meeting the budgetary target and maintaining fiscal discipline with consequent distributional issues associated with a deficit.

When prices started falling in late 2014, the government was generous in passing on the benefit to the consumers as consumer prices were nearly halved. Unlike this, India and Bangladesh mopped up almost the entire saving in higher tax revenues, strengthening their fiscal position in the process.

When prices were stabilised in 2015-16, the government should have avoided fiddling with the formula, except to ensure that budgeted revenues were realised. Instead, it indulged in populism and lost major revenue by constantly lowering applicable taxes to avoid increases in prices. It was, therefore, not surprising to see a major shortfall of Rs259 billion (nearly 0.8 percent of the GDP) in FBR revenues in the last fiscal year. A similar strategy was in view during the current quarter, except for the month of November when the MS price was increased by Rs2.49 and the HSD price rose by Rs5.19.

If the prices were not increased, the revenue loss would have been at least Rs8 billion for the month of November through reduction in the receipts of petroleum levies and sales tax. On an annual basis, this is a significant loss of revenue.

Pakistan still has the lowest fuel prices in the region. Compared to Pakistan, India faces an HSD price that’s 60 percent higher and an MS price that is 23 percent higher. Bangladesh has a slightly worse comparison.

Even when it may be convenient, we must shun mixing politics with economic considerations. The current fiscal year has started as badly in terms of economic inaction as the previous one. There is a need to face the challenges on a war footing.

It has been suggested by some that the prime minister was able to do this because the finance minister was not around. The latter would have had it vetted by the former prime minister, who is still the final arbiter of government policies. We have difficulty in understanding how poor economic decisions could be helpful, even when measured by political calculus. Losses worth $7 billion in reserves, the reversal of a prudent fiscal policy and a number of missteps related to the taxation of the capital market have not helped raise the popularity of the government.      

Voices are being heard from all corners that the economy may soon be heading towards the same state that it was in back in 2013. Alas, this time it will happen when the fundamentals are still very strong.

The writer is a former finance secretary. Email: waqarmkn@gmail.com