Pakistan's fragile coalition government was forced to compromise with a key partner over a fuel price hike on Friday, a move likely to ensure, for now, political stability at the cost of vital economic reforms.
The decision to reduce to almost 5 % a 9.9 % increase in fuel prices announced this week is likely to disappoint the International Monetary Fund (IMF), which has said Pakistan must raise taxes and end subsidies if it wants to continue receiving an economic bailout package.
But the reduction appears to have mollified the Muttahida Quami Movement (MQM), the third-biggest party in the ruling coalition which quit the government in protest over the last fuel price increase in January. It rejoined after the government caved in and reversed that rise.
"By reducing the recent fuel price rise by 50 % on the demand of the MQM, the government has given a big relief to the people," MQM chief Altaf Hussain said in a statement.
The party had given the government three days to scrap the increase that was announced on March 1. Political stability in Pakistan, a nuclear-armed US-ally, is seen as key to fighting al Qaeda and Taliban militants within its borders and in neighbouring Afghanistan.
The government of President Asif Ali Zardari is struggling to cope with a raft of challenges, including a dire economy and a strengthening seam of radical Islam within society. Poverty and dysfunctional state institutions also contribute to making the Pakistan People's Party-led coalition unpopular.
Implementing financial reforms is a condition for the IMF to disburse an $11 billion IMF bailout programme to Pakistan. The fund declined to comment on the fuel price decision, which will come up in meetings with an IMF team now in Pakistan.
Analysts estimated the treasury would lose up to 9 billion rupees ($105 million) a month by agreeing to reduce the fuel price hike. Government officials have said the decision to put off fuel price increase since Oct. 31 had cost the economy 13 billion rupees ($152 million).
Finance Minister Hafiz Shaikh told reporters after meeting representatives of the MQM that the government would now have to "bear more burden".
"The government will need to manage its fiscal deficit and need to adjust this loss of revenue somewhere, it could either further cut its development expenditure or find ways to increase or introduce new taxes," said Khalid Iqbal Siddiqui, director at Invest & Finance Securities Ltd.
Analysts say Pakistan is likely to overshoot a revised budget deficit target of 4.7 % agreed with the IMF in November 2010. Some forecast the deficit to be about 8 %, higher than the central bank's prediction of between 6.0 and 6.5 %, if fiscal reforms are not implemented.
The government will now have to convince the visiting IMF team that it is serious about reform, analysts said. "The picture is not very clear as to what exactly the government's plan is in terms of convincing the IMF but it will have to come up with a credible plan," said Asif Qureshi, director at Invisor Securities Ltd.
The revised fuel price increase is not likely to have a significant impact on inflation, which rose more than 14 % year-on-year in January.
"Fuel's direct impact on inflation is about 4.4 % so its quite minor and the decision to increase fuel prices by almost 5 per cent would affect inflation by just 25 to 50 basis points," said Qureshi.