Iran War, oil prices, and global economy

A crisis that needs careful handling

As the international oil price almost near $120 per barrel, whereby, to be precise on March 19, the price increased by a little more than $10 from the day before, taking the Brent Crude to $119 per barrel, it came down on Friday to around $107 per barrel, highlighting the sudden nature of overall sharp rise in prices since the Iran War started a few weeks ago on February 28. This, in turn, has had a significant negative impact on the global economy. 

With regard to the rise in oil prices, and LNG outlook, a March 19 Bloomberg-published article indicated ‘The price of oil and natural gas jumped as escalating attacks in the Persian Gulf threatened long-term damage to major energy facilities. European gas futures surged as much as 35 percent to more than double their pre-war level and Brent crude rose as high as $119 a barrel. …“LNG from Qatar could in principle be offline for months and, in the worst case, for years,” said Arne Lohmann Rasmussen, chief analyst at Global Risk Management. “For the gas market, the crisis does not end simply because the war ends and the Strait of Hormuz reopens.”’

Moreover, the article highlighted a difficult outlook with regard to oil prices, as follows: ‘Oil has surged about 60 percent since the start of the war. More intensive targeting of upstream energy infrastructure, either in Iran or across the wider region, threatens a longer-term impact on oil prices. “The market is still underestimating and not fully pricing the risk of how quickly this could escalate,” said Haris Khurshid, chief investment officer at Karobaar Capital LP in Chicago. “If this escalates into direct hits then $120 won’t be the ceiling, it’ll be the starting point.”’

Higher energy prices– and in so little time– at the back of mainly the virtual closure of the Strait of Hormuz, and strikes on multiple oil, and gas fields overall in the Middle East in addition to just Iran, is bringing back the global economy to a similar situation, especially in terms of inflation, as was seen in the wake of global supply shock due to the Covid-19 pandemic, and the Ukraine War. Moreover, it will be only some time before the policy rate will likely rise; although for now except for Australia, central banks like the European Central Bank (ECB), and the US Federal Reserve have shown restraint. Yet, the expected rate cuts situation has most probably been thrown out of the window, including for net oil importing countries, like Pakistan. That being said, the world should learn from the misgivings of too hawkish a stand that it took earlier in the decade by adopting over-board monetary, and fiscal austerity policies, which led to unjustifiably high economic growth sacrifice, and pushed a number of countries to a very difficult debt situation. Hence, there is a need for adopting a more balanced approach with regard to aggregate demand squeeze, and aggregate supply boosting policies.

What needs to be highlighted is the important role of multilateral institutions like the International Monetary Fund (IMF) to assist countries in adopting counter-cyclical policies– by supporting their balance of payments situation, especially of net oil importing countries like Pakistan– by releasing meaningful level of special drawing rights (SDRs) on the basis of ‘need’ of a particular country, and not on the routine basis of using the criterion of ‘quota’ for allocation of SDRs, since this is obviously an emergency situation.

Also, instead of using higher policy rate to chase otherwise highly volatile foreign portfolio investment (FPI), and likely significantly contribute to higher imported, cost-push inflationary, and overall balance of payments pressures, it will be much better to induce higher foreign direct investment by keeping the interest rate lower to the extent at least; although overall as well, in developing countries like Pakistan, where inflation is at least equally a fiscal phenomenon, there is all the more need to practice non-austerity, and counter-cyclical policy. 

In addition, there is obviously a need for meaningfully cutting back on non-developmental expenditures, as has been announced in the wake of the Iran War in a number of countries, including Pakistan. Nonetheless, although needed, they are secondary in importance, while the main drives of macroeconomic stability– in particular in terms of managing the fiscal account, and current account– would likely be higher imported, and cost-push, inflation generated by otherwise unnecessary practice of overboard austerity and pro-cyclical policies. 

The bigger picture in terms of the existential threat facing humanity, in the shape of the climate change crisis, needs to be kept in mind while formulating any economic, and environmental policy. The Iran War– just like the Ukraine War, and the covid-19 pandemic, and the fast-paced increase in climate catastrophes in recent years, for instance– has once again highlighted the need to move away from reliance on fossil fuels. Here, what needs to be highlighted is the important role of multilateral institutions like the International Monetary Fund (IMF) to assist countries in adopting counter-cyclical policies– by supporting their balance of payments situation, especially of net oil importing countries like Pakistan– by releasing meaningful level of special drawing rights (SDRs) on the basis of ‘need’ of a particular country, and not on the routine basis of using the criterion of ‘quota’ for allocation of SDRs, since this is obviously an emergency situation.

In this regard, the announcement of the International Energy Agency (IEA) to release an unprecedented level of 400 million barrels to ease the oil supply shortage situation, is indeed an important positive step.