ISLAMABAD (Reuters) - Pakistan's prime minister has agreed to reverse an unpopular fuel price hike under pressure from opposition parties, as he seeks to save his shaky government following the defection of a key coalition partner.
The United States called the decision a "mistake" and the International Monetary Fund, which has an $11 billion loan program with the nuclear armed nation that depends partly on it making painful economic reforms, also voiced misgivings.
The decision -- which a Pakistani official said could cost the government $58 million a month -- along with delays in a planned tax reform could make Pakistan miss its budget targets and endanger remaining payments from the IMF loan.
"All the political leadership has agreed that fuel prices should be reversed," Prime Minister Yusuf Raza Gilani told the National Assembly on Thursday. "I announce a restoration of the prices" to the levels they were on December 31.
The rollback of the 9 percent price increase, which took effect on Friday, was one of several demands made of Gilani's Pakistan People's Party by former Prime Minister Nawaz Sharif's Pakistan Muslim League (PML-N).
Chaudhry Nisar Ali Khan, leader of the PML-N in parliament, said Gilani had "bowed to the demand of this parliament," calling the move a "big act."
One of Gilani's main coalition partners, the Muttahida Qaumi Movement (MQM), announced on Sunday that it was leaving the government in protest of the fuel policy, leaving the prime minister without a majority in parliament.
MQM leader Faisal Subzwari told Reuters on Thursday that while his party appreciated the decision to reverse the increase, it would not rejoin the government.
U.S. Secretary of State Hillary Clinton said she warned Pakistan's ambassador to the United States on Tuesday against reversing the price increase.
"We have made it clear, as I did in a meeting with their ambassador, that we think it is a mistake to reverse the progress that was being made to provide a stronger economic base for Pakistan and we will continue to express that opinion," Clinton told reporters at a news conference.
Analysts also criticized the decision because they said it would negatively impact Pakistan's fiscal deficit.
"This reinforces the feeling ... that political instability is beginning to affect economic decisions," said Sakib Sherani, an independent economist who recently resigned as the economic adviser to the government.
"This is very regressive and there is no justification for it," he told Reuters. "We're not presenting any viable fiscal measures to counter the deficit."
In 2008, Pakistan linked its domestic oil prices to international oil prices.
The decision to reverse the price hike means the government will have to provide a fuel subsidy, increasing its spending and widening its budget deficit by as much as 0.2 to 0.3 percentage points of gross domestic product in the 2010-2011 fiscal year, Sherani estimated.
A senior Petroleum Ministry official told Reuters that the reversal would cost the government around 5 billion rupees ($58 million) monthly.
Combined with a delay in implementing a new reformed general sales tax, analysts said the deficit target of 4.7 percent of GDP for the current fiscal year would be almost impossible to achieve.
This could imperil the remaining payments of an $11 billion International Monetary Fund loan to prop up the economy, which is contingent on ending subsidies and widening the tax base.
The IMF criticized the subsidies on Thursday and said the money could be better spent on social programs.
"They're inefficient and untargeted so that the bulk of the benefit from the energy subsidy goes to higher income individuals and large companies," IMF spokeswoman Caroline Atkinson said from Washington when asked whether reinstating the subsidies would derail the loan.
"We continue to work with Pakistan to see if we can reach agreement on measures that the government can put in place to put its economy on a sounder footing," she said.
The defection of the MQM left Gilani vulnerable to a no-confidence vote in parliament, but the threat of that appeared to have faded even before his reversal on fuel prices.
Instead, analysts expect the opposition to try to slowly squeeze the government, which is already under intense pressure, on several other fronts.
Millions of Pakistanis are growing frustrated at widespread corruption, power cuts, poverty and rising inflation -- problems that risk pushing more young men to join militants groups in the South Asian country of 170 million.
($1=85.70 Pakistani rupee)
Reporting by Kamran Haider and Augustine Anthony; Additional reporting by Emily Kaiser and Arshad Mohammed in Washington; Writing by Chris Allbritton; Editing by Noah Barkin and Stacey Joyce