How declining global oil prices will impact Pakistan's inflation, trade deficit

While declining oil prices in the international market have raised concerns about 'softer' global growth, the development is really positive for countries such as Pakistan that rely heavily on imported fuel.

This drop, if sustained, is expected to help bring down Pakistan's inflation below 9%, reduce its import bill and cut its trade deficit by $900 million to $1.8 billion in fiscal year 2024-25, research by Nukta suggests.

Why are oil prices falling?

Several factors are contributing to the current decline in oil prices. One of the main reasons is a slowdown in global demand, particularly in key economies. OPEC's latest monthly report revised its global oil demand forecast for 2024, dropping it from 2.11 million barrels per day to 2.03 million barrels per day.

The weaker demand outlook, especially from major consumers like China, has significantly affected the market. China's economic slowdown, coupled with a potential US recession, is reducing demand for crude oil, further pressuring prices.

Oil products demand in China is forecast to decrease by 1.1% annually between 2023 and 2025, with the drop accelerating in subsequent years, a China oil researcher told Reuters. Declining Chinese oil demand from the growing adoption of liquefied natural gas trucks and electric vehicles, as well as China's slowing economic growth following the COVID-19 pandemic, has been a drag on global oil consumption and prices.

The US has maintained its position as the top crude oil producer globally for six consecutive years, increasing supply. This has contributed to the oversupply issue, making it difficult for OPEC+ to balance the market through production cuts. Despite ongoing efforts by Saudi Arabia and other OPEC+ members to curb production, the surge in US output and weaker demand have exacerbated the price decline.

Read our detailed piece: Oil price plunge: How did the market react and will it give the Fed room to cut rates?

The impact on Pakistan

Import bill

Pakistan's petroleum imports account for 30% of its total imports. The country spends 55% of what it earns through its exports to finance these petroleum imports. This makes them a significant driver of the trade deficit.

The share of oil import in FY24 also decreased to 29% from 36% in the previous fiscal year. This reduction is attributed to lower oil prices and reduced volumetric imports due to the economic slowdown. Realized oil prices were 3% ($3 per barrel) lower for crude oil and 6% ($6 per barrel) lower for petroleum products in FY24 compared to FY23.

In FY24, Pakistan imported 10.4 million tons of petroleum products and 9.1 million tons of crude oil.

The average Brent price in FY23 was $87.19 per barrel while the country's petroleum imports stood at $12.6 billion. In FY24, average crude prices declined 3.06% to $84.52/bbl and petroleum imports also declined 3.9% to $12.1 billion.

Analysis suggests that for every $5 per barrel drop in oil prices, Pakistan's annual oil import bill could decrease by $900 million, with potential savings doubling if oil prices fall by $10 per barrel.

According to Nukta research, if the average crude prices remain at $79.2 for FY25— down $5/bbl from FY24 level — the petroleum import bill may decline by $900 million. Moreover, average oil prices at $74.2/bbl may slash the import bill by $1.8 billion in the current fiscal year. If they remain at $67.2/bbl, the reduction in the import bill comes to $3.1 billion.

Since July 1, crude prices have declined by $17/bbl as on September 10.

Trade deficit and inflation

Pakistan's trade data for July reveals that crude oil and petroleum product prices were purchased at an average of $83/bbl, while global oil prices have reduced 12% ($10/bbl) from those levels.

Lower oil imports may also create more room for some non-essential imports, keeping current account balance close to breakeven.

Easing oil price has begun to contribute to inflation already, with a 5% reduction in local petroleum product prices in the last six months. Inflation eased back to the single-digit range in August after three years, which has raised hopes of further cuts in the interest rate.

Oil prices directly impact the 6% weighted transport segment of the inflation basket, and a $5 per barrel decline could reduce inflation by 22 basis points. However, this only reflects the direct impact, with the overall effect — including second-round impacts — likely to be greater. In August, the transport index saw a 0.7% decline, driven by lower oil prices.

The government might seize this opportunity to increase the Petroleum Development Levy by PKR 10 per liter (4% of present petroleum product price level) to its revised cap of PKR 70 per liter, helping to offset the shortfall in PDL collection due to sluggish oil market companies' sales.

While declining global oil prices could be a boon for Pakistan, the US Energy Information Administration expects ongoing withdrawals from global oil inventories may push prices back above $80/bbl this month.