Pakistan’s Exposure to a Strait of Hormuz Shock: Fuel Pricing, Inflation, and External Vulnerability

CONTENTS

ABSTRACT

1. Introduction

2. First-Pass Transmission Evidence

2.1.  Historical Pass-through from Brent Crude to Domestic Petrol Prices

2.2.  Why the Current Episode Points to a Stronger Pass-through

2.3.  Which Parts of the CPI Basket are Most Exposed

3. Analytical Framework and Nonlinear Scenario Design

3.1.  Domestic fuel pricing and pass-through

3.2.   Why a nonlinear framework is needed

3.3.   Scenario Design

3.4.  Baseline Assumptions and Monthly Pass-Through Logic

4. Scenario Analysis

4.1 Baseline and scenario assumptions

4.2.  Translation into Domestic Fuel Prices

4.3.  Month-wise Inflation Path

4.4.  Cumulative inflation effect

4.5.  External-Sector Signal

5. External Sector and Macroeconomic Implications

6. Conclusion

7. Policy Recommendations

References

Appendix A. Technical Methodology

ABSTRACT

This paper investigates how a disturbance in the Strait of Hormuz could impact Pakistan through fuel prices, inflation, and external-sector pressure. Using a nonlinear scenario framework, it models three cases (mild, stress, and severe) by including war-risk premium, exchange-rate effects, separate shocks to motor spirit (petrol) and high-speed diesel, threshold-based indirect CPI impacts, and staggered monthly pass-through. The results indicate that even a mild shock can disrupt Pakistan’s recent disinflation trend. The stress and severe scenarios lead to substantially higher inflation because diesel-driven transportation and food-distribution costs amplify second-round effects. The findings also show that the shock affects more than just pump prices; it raises the petroleum import bill, weakens the current account, and limits policy options. The paper concludes that an effective response involves a coordinated approach (based on transparent pass-through, targeted support for critical logistics, and active external-sector management) rather than broad price controls.

1. INTRODUCTION

Oil price shocks remain among the most powerful external disturbances, transmitting into domestic inflation, production costs, and external-sector stress in oil- importing economies. Since Hamilton’s seminal contribution, the literature has shown that higher oil prices are not merely a commodity-market event; they alter macroeconomic conditions by  raising  input costs,  compressing household real  incomes, weakening aggregate demand, and complicating monetary management (Hamilton, 1983). Oil shocks differ in origin and therefore do not produce identical inflationary or macroeconomic effects across countries and policy regimes (Kilian, 2009). For developing oil-importing economies such as Pakistan, however, the relevant domestic disturbance is rarely crude oil alone. What eventually reaches households, transporters, generators, manufacturers, and retailers is the delivered and administered price of petroleum products after freight, insurance,  exchange-rate conversion,  margins,  and  fiscal  charges  are  added  to  the benchmark price (Hina & Malik, 2024).

This question has become immediately relevant because the Strait of Hormuz has once again become a major conduit for global energy instability. The U.S. Energy Information Administration reports that around 20 million barrels per day moved through the Strait in 2024, equivalent to roughly one-fifth of global petroleum liquids consumption, while the same route also carried a substantial share of global LNG trade (U.S. Energy Information Administration, 2025). In normal times, that alone makes Hormuz strategically important. Under current conflict conditions, the implications are sharper. Recent reporting indicates that the disruption has not only raised benchmark oil prices but has also intensified freight costs, shipping delays, and war-risk insurance premiums, thereby increasing the effective landed cost of petroleum imports for energy- dependent economies. For Pakistan, this means the relevant shock is broader than crude oil alone; it is a compound cost shock transmitted through trade, transport, and pricing channels.

Pakistan’s exposure to such a disturbance is structural rather than temporary. According to the State Bank of Pakistan’s Annual Report 2024–25, the country’s total energy import bill stood at US$15.9 billion in FY2025. Within this, petroleum products accounted for US$5.96 billion, crude oil for US$5.45 billion, LNG for US$3.48 billion, and LPG for about US$1.06 billion (State Bank of Pakistan [SBP], 2025). As such, imported energy remains deeply embedded in Pakistan’s external account. Even when international prices soften temporarily, the economy remains vulnerable to renewed external price shocks. Petroleum pricing is economically sensitive because petroleum products remain central to transport, production, and fiscal management, while import dependence keeps domestic prices exposed to international volatility (Hina & Malik, 2024). In practical terms, this means that an external oil shock does not stay confined to the energy account; it quickly becomes an inflation, balance-of-payments, and policy- management issue.

Pakistan’s inflation trajectory had already begun to turn upward before the latest escalation in the Middle East. The Pakistan Bureau of Statistics reported that headline CPI inflation rose from 5.85 percent in January 2026 to 6.98 percent in February 2026; urban inflation reached 6.79 percent and rural inflation 7.27 percent. Within the CPI basket, Housing, Water, Electricity, Gas, and Other Fuels increased by 9.65 percent year-on-year in February, while Food and Non-Alcoholic Beverages rose by 5.82 percent (Pakistan Bureau of Statistics [PBS], 2026). On 9 March 2026, the State Bank of Pakistan kept the policy rate unchanged at 10.5 percent and cited heightened uncertainty following the outbreak of war in the Middle East (SBP, 2026). On the same day, Reuters reported that Pakistan had also moved into emergency fuel-saving measures after a sharp jump in domestic petrol and diesel prices, underscoring how rapidly external oil-market stress can spill into domestic policy action (Reuters, 2026d, 2026e). The present shock, therefore, is arriving at a moment when inflation risks are already becoming harder to contain.

The domestic transmission of oil shocks in Pakistan is well established in the literature. Asghar and Naveed (2015) find significant long-run pass-through from world oil prices to inflation in Pakistan. Hyder and Hussain (2019) further show that this pass- through is asymmetric and nonlinear rather than constant across episodes. That distinction is important for the present paper. A modest increase in international oil prices may generate a manageable first-round fuel effect. A sustained disruption in Hormuz, by contrast, can trigger a wider chain involving war-risk premia, freight disruption, exchange-rate amplification, and stronger second-round inflation. In Pakistan’s context, this transmission also differs across petroleum products. Motor spirit affects household mobility and inflation salience more directly, whereas high-speed diesel has broader downstream consequences for freight, agriculture, food distribution, and supply-chain costs. Once the diesel channel intensifies, inflation moves beyond fuel stations and spreads through the wider cost structure of the economy (Asghar & Naveed, 2015; Hina & Malik, 2024; Hyder & Hussain, 2019).

This is where the present paper departs from a simple oil-price note. The issue is not whether oil matters for Pakistan; that is already known. The real policy question is how to assess a shock in which benchmark crude prices, marine freight, insurance premiums, and exchange-rate pressures can all move at the same time. A single linear elasticity is too blunt for that setting. The paper, therefore, treats the Strait of Hormuz episode as  a  nonlinear transmission problem for  an  import-dependent economy. It combines first-pass evidence on Pakistan’s oil-price sensitivity with a scenario framework built around war-risk premium, exchange-rate amplification, separate shocks to motor spirit and high-speed diesel, threshold-based indirect CPI effects, and scenario-dependent monthly pass-through weights. The objective is not to create an illusion of forecasting precision. It is to provide a disciplined policy framework on how a Hormuz disruption could pass-through Pakistan’s fuel-pricing system, inflation path, and broader macroeconomic vulnerability under mild, stress, and severe cases (Reuters, 2026a, 2026c; SBP, 2025; U.S. Energy Information Administration, 2025).

The rest of the paper proceeds as follows. Section 2 presents the first-pass evidence on domestic fuel pass-through and CPI basket exposure. Section 3 sets out the analytical framework and nonlinear scenario design. Section 4 reports the Excel-based scenario analysis, while the remaining sections interpret the macroeconomic implications and develop the policy response. The central argument is straightforward: for Pakistan, a Strait of Hormuz disruption should be treated not as a narrow energy-price event, but as a combined inflation, import-cost, and policy-coordination shock (PBS, 2026; SBP, 2026).

2. FIRST-PASS TRANSMISSION EVIDENCE

This section provides a historical view of Pakistan’s vulnerability to external oil shocks. The main policy question is not whether international oil prices impact Pakistan; that is already clear. Instead, the more important question is how the shock usually influences domestic fuel prices, whether current conditions are causing a stronger-than- normal pass-through, and which parts of the inflation basket are likely to be affected first. These issues are important because policy cannot rely solely on headlines about oil markets. It must be based on the actual transmission patterns seen in Pakistan’s price system.

2.1. Historical Pass-through from Brent Crude to Domestic Petrol Prices

Over the last decade, the relationship between Brent crude prices and Pakistan’s retail petrol prices has been positive and economically meaningful, but not one-to-one. Monthly data indicate an average pass-through elasticity of around 0.30 from international oil prices to domestic petrol prices. In practical terms, this implies that a 10 percent increase in world oil prices has historically been associated with an increase of roughly 3 percent in retail petrol prices in Pakistan, while a 20 percent external oil shock would imply a petrol price increase of around 6 percent.

This is an important benchmark because it captures the historical pattern under relatively normal conditions, as shown in Figure 1. Pakistan’s retail petrol price does not move mechanically with the crude benchmark. The transmission is filtered through exchange-rate conversion, import-parity pricing, inland freight equalization, dealer and marketing margins, and the policy treatment of petroleum levy and related charges (Hina & Malik, 2024). As a result, international oil shocks do pass-through, but the pass-through is usually partial rather than complete. That interpretation is consistent with the broader Pakistan literature, which finds significant oil-price transmission to inflation without implying a fixed one-for-one retail adjustment in every episode (Asghar & Naveed, 2015; Hyder & Hussain, 2019).

Higher fuel prices affect inflation both directly and indirectly because petroleum products are deeply embedded in the Consumer Price Index (CPI) basket and are also essential inputs for transportation and production. Figure 2 further indicates that petrol price movements are closely aligned with the inflation path, suggesting that fuel-price shocks can transmit beyond the energy component into broader price pressures across the economy.