Effect of Rising Oil Prices on Trade Balance of Pakistan

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EFFECT OF RISING OIL PRICES
ON PAKISTAN
TRADE BALANCE

ABSTRACT:

The objective of this term paper is to explore the correlation between rising oil prices & deterioration in trade balance of Pakistan. This paper analyzes how the increase in oil prices affect the import bill & export earning of Pakistan .The study consist of annual data for the period 1985-2010.Pakistan is not an oil producing rather oil-importing country. 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 $148 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...
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