Prime Minister Imran Khan has done well by making a pit stop in Saudi Arabia while on his way to the US. The markets have reacted sharply to the drone attacks on Abqaiq and khurais, wiping off (albeit temporarily) nearly 5.7 million barrels per day from the global crude supplies – Crude since touched $60/barrel, an unprecedented rise of nearly 12% in one go. With winters approaching when the annual demand of oil peaks and with an uncertain political situation in the Persian Gulf, some experts predict the oil prices to touch $ 80/barrel by December ’19.

In these uncertain times, especially with a threat of war from India over Kashmir, Pakistan can ill afford any disruptions in its oil supplies, which constitutes as the main commodity in its imports. And for Pakistan, Saudi Arabia is not only the principal supplier of its oil, but more importantly, does so on credit. However, assurances from our Bedouin friends aside, the trouble is that cash or credit, once the oil prices start climbing, it invariably spells trouble for the frail Pakistani economy. This time also it will be no exception, since with a weak rupee (perhaps devalued nearly 15% more than what was necessary), dwindling remittances owing to a global slow down in general and in the Gulf Countries in particular (Pakistan’s incoming remittances have primarily dropped from the Gulf), stagnant exports and virtually absent FDI, the looming current account challenges in the coming months are expected to be aplenty.

In addition, the hanging FATF sword coupled with a rising fiscal deficit are likely to further exacerbate the situation, as both things in their own right can seriously hamper our ability to raise cheap - or rather any capital at all - from the international financial markets. As if all this was not enough of a scare, one must remember that a surge in oil prices is almost always accompanied by a rise in the US Dollar (being the underlying currency for trading in oil), a development that could further put pressure on the Pak Rupee (perceived to be closely linked to it with an inverse relationship) thereby pushing the country deeper into a devaluation and an inflation trap.

So how do we prepare for such a situation? Before getting into what needs to be done, let’s first try to rule out the options we cannot exercise. First, reckon, using Iran as an alternate source of oil, closer to home, stands ruled out as we have clearly aligned ourselves to its opposing side – ironically the same cannot be said about our friends for us, as was recently demonstrated by the traction Mr. Modi found in these Arab countries. Second, unlike in the past, China this time may have some reservations in coming to our rescue, as it moves ever more closer to Iran while at the same time becoming a bit vary of Pakistan owing to our current handling of its CPEC initiatives. Lastly, Qatar too has become cautious after being unnecessarily dragged into our internal LNG controversies. What this means is that essentially the government needs to start preparing for such eventualities by dispensing some sound economic management at home. It only has to look back about 10 years into Pakistan’s own economic history to realize what damage can high oil prices do: High double digit inflation; massive load shedding; slow growth and unemployment with effective borrowing rates for businesses climbing to more than 20% at the time.

In all fairness to the government the difficulty is that oil price risks are difficult for any government to bear. In absence of real options on easily available financing opportunities, as explained above, when price goes up, governments in general have to either cut expenditure or raise revenue. This is difficult to do quickly and especially difficult to do efficiently. Also, it runs the danger of making the fiscal policy pro-cyclical, putting a heavy burden on the private sector and the poor, leading to macroeconomic instability (e.g. monetary, financing, exchange rate fluctuations, debt rescheduling and variable economic growth) and possibly social and political unrest. Increasing spending when prices rise is easier but again difficult to do efficiently, especially when resources are already scarce (as in our case). The other challenge that springs up from this relates to difficulty in planning, for example, suddenly basing a budget on oil price assumptions that in itself could indeed turn out to be very wrong. But then on the other hand if the short-term risk of an oil price increase is very real, inaction also is not an option.

There are numerous examples on mitigating the uncertainty over-oil price-increase risks (Brazil, South Africa, Thailand, South Korea, Taiwan and Sri Lanka to name a few) where governments have successfully taken a number of preemptive actions when they saw a clear writing on the wall. For example: To help deal with oil price risks, these government mainly established oil stabilization funds. The idea being that a stabilization fund will smooth out the fluctuations in the international price of oil and stabilize the stream of government’s expenditure of oil. However, this is not easy by any stretch of imagination. The problem invariably though which is faced in such a case is that when a country that needs such financing goes out shopping in the international markets it generally finds out that it is in fact not in a position to raise such funds in a timely and cost effective manner. Therefore, what it needs to do (and what was also done by most of the countries cited above) is to simultaneously also start (gradually) implementing a host of other related internal and external measures that include steps like,

*   Rationing: To cut on unnecessary and luxury usage to bring down the total spend.

*   Futures Strategy: To lock in now the oil price that the government knows it will receive in future.

*   Options Strategy: To set in a domestic minimum price now based on the oil price the government is sure of getting in the future.

*   Boosting other sources of raising foreign exchange: Namely Exports & Foreign Direct Investment.

Ironically, nearly 14 months down the road in this new step and a comprehensive exports strategy cum policy is still missing!

Fundamentally, success in overcoming oil-price-increase risks will primarily hinge on how sound is a government’s economic management, meaning how efficiently it allocates its resources amongst different sectors of the economy, importantly vis-a-vis domestic manufacturing. Thereafter, the interaction between the macroeconomic dynamics resulting from sticky prices and the proverbial Marshallian dynamics arising from sluggish or efficient factor allocation will decide the fate of such governmental efforts.

While surely the focus is always on the long-run effects of a stabilization policy, it is important to remember that an intervention is not taking place in a vacuum, but rather it is evolving in response to some specific exogenous disturbances. The dynamic response of the economy thus reflects both the “natural” response following the shock and the “induced” response to the government policy itself. What is required of our economic team is to quickly take cognizance of the situation and not only start taking some immediate steps to prepare the country for the looming oil price rise, but also give a comprehensive policy framework in this regard aimed at mitigating the arising risks from the oil supply disruptions in Saudi Arabia and possibly from the renewed tougher sanctions on Iran. If timely measures are not taken, then we might find ourselves confronting the same level of adversity as when the oil prices crossed the $100/barrel mark, albeit this time the difference being that people may not have the same patience as before to bear the pain quietly!