As the conflict involving Iran, the United States and Israel enters its second month, Pakistan’s economy stands at a critical and increasingly perilous juncture. What appeared in late 2025 as a tentative stabilisation—with moderating inflation, steady remittance inflows and modest growth—has been violently upended by the surge in global energy prices.

The government’s decision on 2 April 2026 to implement a massive fuel price adjustment, effective 3 April, has crystallised the risks. Petrol prices have jumped by Rs 137.24 to Rs 458.41 per litre, while high-speed diesel (HSD) has soared by Rs 184.49 to Rs 520.35 per litre. These increases follow an earlier Rs 55 per litre hike in early March and represent a cumulative rise of approximately 66 per cent in petrol prices since the conflict began.

The move combines the full pass-through of higher imported oil costs with a deliberate increase in the Petroleum Development Levy (PDL) on petrol—from around Rs 106 to Rs 161 per litre—to make up for shortfalls in meeting overall tax revenue targets. At the same time, the PDL on diesel has been abolished entirely. Far from merely curbing implicit subsidies, this policy has dramatically amplified the threat of resurgent inflation and economic stagnation.

Pakistan’s response stands in sharp contrast to several other Asian economies. There has been no or negligible increase in petrol prices in India, Bangladesh and Indonesia despite the same global shock. In this regard, Pakistani consumers—alongside those in Myanmar and the Philippines—rank among the worst hit in Asia and the world.

A key reason is the weak financial position of these countries. In Pakistan’s case, the government is trying to make up for the shortfall in tax revenue targets by hiking taxes on petrol and passing on the burden of rising imported oil prices. Despite active diplomacy and heightened visibility in efforts to end the war and secure a ceasefire, Pakistan has not been able to secure oil at concessional rates from Gulf countries, though it has secured some regular shipments.

Global oil markets remain chaotic, with physical spot prices for Brent crude exceeding $140 per barrel—the highest since 2008—amid disruptions in the Strait of Hormuz. Futures prices hover lower, but the real-world cost of imported barrels, particularly Dubai crude benchmarks used in Pakistan’s pricing formula, is what the economy must absorb.

This aggressive pass-through, layered with additional taxation via the PDL, will feed directly and rapidly into broader price levels. Fuel costs flow almost immediately into transport fares, logistics expenses, food prices and electricity tariffs. In an economy where low- and middle-income households allocate 40–50 per cent of their budgets to essentials, the impact will be immediate, widespread and regressive.

Official data for July 2025 to February 2026 show merchandise exports at approximately $20.5 billion, down about 7 per cent year-on-year, while imports climbed to $45.5 billion, up roughly 8 per cent

Official data for July 2025 to February 2026 show merchandise exports at approximately $20.5 billion, down about 7 per cent year-on-year, while imports climbed to $45.5 billion, up roughly 8 per cent

Headline inflation, which had eased to single digits earlier in the fiscal year, is now projected to accelerate sharply. The Ministry of Finance estimates March 2026 inflation at 7.5–8.5 per cent year-on-year, with independent analysts warning it could breach double digits in April and sustain elevated levels through the second half of FY26.

The State Bank of Pakistan has long cautioned that large energy price discrepancies distort incentives, stoke inflationary expectations and undermine monetary policy transmission. Diesel—the lifeblood of freight, agriculture, power generation, construction and small-scale industry—now at historic highs, will exert particularly severe cost-push pressures.

Transport and logistics costs are expected to rise by 15–20 per cent in the coming months, directly feeding into higher prices for perishables (which carry a heavy weight in the CPI basket), construction materials and manufactured goods. Second-round effects—wage demands in both formal and informal sectors, higher input costs for exporters and eroded consumer confidence—could turn a one-time shock into entrenched stagflation, mirroring the painful experience of the 2008 global oil crisis when Pakistan’s inflation spiked above 25 per cent.

The government has attempted to cushion the blow through tightly targeted relief measures. Two-wheeler users, who number nearly 29 million registered motorcycles and represent the primary mode of private transport for 40–45 per cent of households, will receive a Rs 100 per litre subsidy, capped at 20 litres per month for three months.

Small farmers will receive a one-time Rs 1,500 per acre support to offset higher diesel costs during the critical harvest season. Some relief has also been extended to inter-city and goods transport on HSD, with monthly reviews. These interventions are far more contained than earlier open-ended proposals and are designed to limit the fiscal impact while protecting the most vulnerable.

Earlier estimates suggested that unchecked implicit subsidies—the gap between import parity and domestic prices—could have reached Rs 300 billion (roughly 0.25 per cent of GDP) over the first 12 weeks of the conflict. In March alone, the federal government authorised more than Rs 129 billion in price differential claims to oil marketing companies.

The April adjustment, combined with the PDL restructuring, significantly reduces that blanket burden going forward but does not eliminate the inflationary spillover or the political fallout from such steep price increases.

Fiscal constraints and ongoing engagement with the International Monetary Fund have left little room for manoeuvre. The IMF has consistently emphasised transparent, cost-reflective energy pricing and the elimination of implicit subsidies to safeguard fiscal targets. Pakistan has committed to passing on future price increases to consumers if additional budgetary space cannot be found.

In a rare display of intergovernmental cooperation, federal and provincial authorities agreed under the National Finance Commission (NFC) formula in late March to share the burden of oil subsidy obligations. This arrangement provides some breathing room but underscores the limits of federal absorption capacity.

Budgetary pressures are acute: the government is already grappling with shortfalls in tax revenue targets, and the decision to hike the PDL on petrol was explicitly aimed at generating additional revenue to bridge that gap. The PDL remains a major revenue source, with collections exceeding Rs 828 billion in the first half of FY26 and annual targets approaching Rs 1.3 trillion.

Yet its uneven application—extremely high on petrol and zero on diesel—reflects a delicate balancing act between revenue needs and selective relief.

Broader macroeconomic vulnerabilities compound the danger. Official data for July 2025 to February 2026 show merchandise exports at approximately $20.5 billion, down about 7 per cent year-on-year, while imports climbed to $45.5 billion, up roughly 8 per cent. The resulting trade deficit of $25 billion is 25 per cent wider than the previous year.

February alone recorded exports of $2.3 billion against imports exceeding $5.2 billion. The imbalance reflects robust domestic demand for energy and consumption goods at a time when global demand for Pakistani textiles, garments and other exports remains subdued.

Failure to contain the inflationary surge while preserving fiscal credibility could tip the economy from fragile recovery into prolonged stagnation

Failure to contain the inflationary surge while preserving fiscal credibility could tip the economy from fragile recovery into prolonged stagnation

Remittances have provided a vital buffer, rising 10.5 per cent to $26.5 billion in the first eight months of FY26. Yet more than half originate from Middle Eastern economies, particularly Saudi Arabia and the UAE. While high oil prices may temporarily support Gulf labour demand, any slowdown in construction or services there would have outsized consequences for Pakistan’s external financing and rupee stability.

The energy shock is deepening the divergent, K-shaped nature of the recovery. Rural and agricultural segments, less energy-intensive and supported by informal safety nets, may prove relatively resilient in the short term.

By contrast, formal manufacturers, export-oriented industries, small and medium enterprises, and low-income urban households face acute pressure. Rising transport and electricity costs are squeezing manufacturing margins and export competitiveness at precisely the moment when global demand is soft.

Energy-intensive sectors such as textiles (which account for over 60 per cent of merchandise exports) could see profitability erode further, potentially leading to factory closures, job losses and reduced foreign exchange earnings. Low-income households, already stretched by cumulative inflation in food and transport, will experience the sharpest erosion of real incomes, widening inequality and risking social tensions.

The policy debate has shifted from broad subsidies to more precise levers. A more macroeconomic approach would involve a calibrated, formula-based adjustment in the PDL—perhaps linking it dynamically to global prices—to dampen cost-push pressures across sectors without sacrificing long-term fiscal space.

The recent NFC sharing mechanism and targeted subsidies have created limited room for such flexibility, yet the tension between revenue needs and growth support remains unresolved. Looking further ahead, Pakistan could draw lessons from Asian peers by establishing a structured government-level oil hedging programme—using futures, swaps and options to lock in prices for 30–50 per cent of imports—thereby smoothing volatility and reducing the need for emergency subsidies or abrupt tax hikes.

Beyond immediate pricing, a credible response must confront Pakistan’s structural fragilities. Heavy dependence on imported fuels exposes the economy to repeated external shocks. Accelerating energy diversification—through renewables, efficiency upgrades and domestic exploration—remains essential but chronically underfunded.

Export competitiveness demands more than cost relief: sustained investment in quality upgrading, digitalisation, market diversification beyond traditional buyers, and trade facilitation is required. Deepening financial inclusion, expanding credit guarantees, and providing targeted support to micro, small and medium enterprises can help bridge the formal-informal divide and foster inclusive growth.

Without these measures, the current shock risks hardening into a structural trap of higher inflation, weaker investment and stagnant productivity.

Even if active hostilities ease, global energy markets are unlikely to normalise swiftly. Supply chains adjust slowly; elevated risk premia in freight, insurance and credit persist; and geopolitical uncertainty may trigger lasting shifts in energy production and consumption patterns. A return to pre-conflict price levels is far from assured.

Pakistan has so far maintained social cohesion under strain, but the policy choices of the coming weeks—balancing the April price hike, targeted subsidies, PDL restructuring and potential hedging strategies—will prove decisive.

Failure to contain the inflationary surge while preserving fiscal credibility could tip the economy from fragile recovery into prolonged stagnation. The alternative is a coherent framework that pairs immediate, precise relief with disciplined macroeconomic management and structural reform.

Only then can Pakistan navigate this energy shock without sacrificing years of hard-won stability and equity. The window for decisive action is narrowing rapidly.

© The Friday Times