Vol. 5 Num 694 Sat. May 13, 2006  
Front Page

Oil Price Adjustment
Future on a slippery path

As oil prices remain volatile, different scenarios are emerging about its impact on Bangladesh economy -- whether the foreign exchange reserves can withstand the price surge, whether inflation will hit the ceiling, and whether interest rates will be so high as to stymie production.

Estimates show, if fuel price reaches $75 a barrel, not much higher than the current $73, the government will need an additional $409 million in fuel bills. But if it hits $85 a barrel, as many analysts predict, the bill will increase by $677 million. The question remains whether the economy can absorb such a shock.

A preliminary analysis of a foreign financial institution says if the growth in exports, workers' remittance and FDI inflow continues to the extent of $2.3 billion more in FY06 over FY05, the economy can soak up the impact without much difficulty, and inflation and exchange rate would not be affected. This idea stems from the fact that in the last 24 months, Bangladesh has withstood a significant jump in oil price from $30 a barrel to $68.

But in an unlikely situation of foreign exchange inflow stagnation and a rise in import of non-food items -- say in the range of 20 per cent -- exchange rate could hit as high as Tk 84 to a dollar. In such a case, inflation may increase by 1 to 3 per cent, if the government finances the additional imports of oil from domestic banks, leading to liquidity pressure.

In the event of oil price hitting $85 a barrel, a wide spectrum of sectors including petrochemicals, chemicals, cement, essential commodities, and marketing will be directly hit. If the high price level persists for more than six months, most consumer industries will suffer an interest rate hike.

And if the government continues subsidising internal fuel prices, this will increase the fiscal deficit by 0.8 per cent of the GDP when fuel price stands at $75 a barrel and by 1.3 per cent of GDP at $85 a barrel.

But, against such possibilities, the government is now basically handicapped to increase domestic oil prices substantially. But if the latest proposal of the government to increase diesel price by Tk 5 and octane by Tk 6 is materialised, the additional burden on the consumers will be Tk 200 crore a month, a Centre for Policy Dialogue (CPD) estimate shows.

"There will be a temporary impact [of internal oil price increase], but it will be desirable," a World Bank economist told The Daily Star yesterday. "It will help ease the pressure on balance of payments and increase liquidity in the market to offset interest rate hike."

The Bank feels the strategy of a big increase in octane price and a small increase in diesel price will not work well, as out of the 3.7 million tonne petroleum products imported a year, a huge proportion of 2.4 million tonne is diesel and 0.4 million tonne is kerosene, while octane's share is only 0.35 million tonne.

"Agriculture is not operating at an economically efficient level when diesel price is kept artificially low," the World Bank economist argued. "The optimal use of input depends on relative price. So, if diesel price increases, allocation efficiency will improve in agriculture."

But if price is not increased, the economy will lose its efficiency and the financial system will collapse through subsidisation, the economist said. The bleeding will be more and the people will be hurt all the same.

Although Dr Debapriya Bhattacharya, executive director of the CPD, agrees with the need of increasing fuel prices, he said the additional burden has to be shared by the government and consumers, and lessened by the arrangement of concessional funding of fuel import.

"Diesel price has to be increased, but not as much as the donors prescribe," he said. "The increase should be lowered by shifting the attention to octane price hike."

He feels the people have to mitigate the Tk 200 crore additional burden resulting from a fuel price hike by either increasing income through efficient activities or by cutting consumption.

"Since there is little scope for income increase, people will first reduce consumption of non-basic goods and then basic goods," he added. "This is why it is more important to keep diesel price increase as minimum as possible. Any relief to the poor, however trivial it may seem in terms of total amount, will still help support their consumption pattern."