KARACHI - One of the most difficult policy choices in the budget of 2008-09 is determination of the appropriate level of prices of petroleum products in response to the sharp jump in international oil prices, which have virtually doubled over the last one year. The lack of adjustment of domestic POL prices last year to this development led to a large increase in the oil subsidy which is reflected in the budget as deferred claims of OMCs. According to the Finance Minister's statement of the April 9th, this liability has increased to Rs 153.6 billion in 2007-08 as compared to the original provision of only Rs 15 billion. Therefore, in the absence of a clear policy on linking domestic POL prices to international prices, the implied oil subsidy has emerged as one of the principal reasons why the fiscal deficit in 2007-08 has risen so sharply in relation to the original target set at the beginning of the financial year. The issue of domestic POL prices not only has significant fiscal policy implications but could also impact on the overall price level in the economy, on the level of competitiveness of Pakistani industry and on the level of energy demand in the economy which would determine the size of the oil import bill that has made a major contribution to the deterioration in the balance of payments position of the country. Therefore, the setting of domestic POL prices is confronted with serious policy tradeoffs which have to be carefully considered by the govt. The objective of this section is to identify first the extent of price adjustment that has been made since March 1 2008, after a period, since January 2007, when prices remained unchanged despite underlying increase in international prices. The apparent explanation for this is the reluctance to raise prices prior to general elections. We derive on an annualised basis the extent to which the oil subsidy has been reduced effectively in 2008-09 due to the recent price increase. The next part of the analysis relates to the estimation of the present level of subsidy (as of May 31st 2008) on individual POL products and the extent of taxation, principally the General Sales Tax. This enables derivation of the projected net subsidy bill in 2008-09 on the basis of currently prevailing prices. The Prime Minister has apparently indicated in his meeting with the Vice President of the World Bank on May 27, 2008 that the govt has decided to eliminate the subsidy on POL products in a phased manner in 2008-09, in order especially to relieve the pressure on the budget. This is a major policy decision. We derive the extent to which prices will have to be raised in order to achieve this goal of subsidy elimination. Finally, some of the broader implications of the POL price enhancements are indicated. Recent increase in POL prices, the Oil and Gas Regulatory Authority (OGRA) makes recommendations to the govt on the level of POL prices (except high speed diesel oil) on a fortnightly basis. After a gap of over one year the first price increase was announced on March 1st 2008 at the fag end of the tenure of the caretaker govt, followed by another increase on March 16th. Thereafter, following the induction of the new govt, two more price increase have been announced on April 18th and May 1st respectively.