Download DETERMINANTS OF FOOD PRICE INFLATION IN PAKISTAN: AN

IN THE NAME OF ALLAH, THE MOST BENEFICIENT,
THE MOST MERCIFUL
DETERMINANTS OF FOOD PRICE INFLATION IN
PAKISTAN: AN EMPIRICAL ANALYSIS
MUHAMMAD ABDULLAH
DR. RUKHSANA KALIM
INTRODUCTION
 In the recent years, food price inflation has risen very
sharply at global level. According to Commodity
Research Bureau (2009), the overall and food
inflation rates at global level stand at 16.5 and 30.2
percent respectively by November 06, 2007. This
high food inflation persists in most of the countries in
the world.
 Reduced level of poverty, increase in per capita
income, urbanization and change in dietary habits
are the main reasons of sharp increase in demand
and prices of some basic food items.
INTRODUCTION
 Because of higher food inflation households have to
make reductions in some areas of food consumption
leading to malnutrition.
 Malnutrition results in productivity losses of up to 10
percent of lifetime earnings and GDP losses of 2-3
percent.
(Alderman, 2005)
 High inflation erodes the benefits of growth and
leaves the poor worse off.
(Esterly and Ficsher, 2001)
INTRODUCTION
 It hurts the poor more, since more than half of the
budget of low wage earners goes toward food.
 It redistributes income from fixed income groups to
the owners of assets and businessmen and
increases the gap between rich and poor.
(Khan et al, 2007)
 Pakistan has also experienced high food inflation of
17.5 percent and 26.6 percent in 2007-08 and
2008-09 respectively. Moreover, food inflation
remained more than 10 percent on average from
1972 to 2009, in the whole history of (West)
Pakistan.
Historical Inflationary Trends 1971-72 to 2008-09
(Annual percentage change, period average)
Years
Overall CPI
Food CPI
70’s
13.3
13.8
80’s
7.2
7.9
90’s
9.7
10.1
2000-01
4.4
3.6
2001-02
3.5
2.5
2002-03
3.1
2.9
2003-04
4.6
6.0
2004-05
9.3
12.5
2005-06
7.9
6.9
2006-07
7.8
10.4
2007-08
12
17.5
2008-09
22.4
26.6
2009-10 (Jul-April)
11.5
12
LITERATURE REVIEW
Two Schools of Thoughts (sources of inflation)
1.
Monetarist
Friedman (1968, 1970 and 1971), Schwartz (1973)
Demand-side factors (money supply, real money balances)
2.
Structuralist
Sunkel (1958), Streeten (1962), Olivera (1964), Baumol (1967) and
Maynard and Rijckeghem (1976).
Supply-side factors (food prices, administered prices, cost of
production, wages and import prices )

Bhattacharia and Lodh (1990)
Supported the strctulists model of inflation for India

Balkrishnan (1992, 1994)
Prices of food grains were determined by per capita output,
per capita income in agriculture sector and government
procurement of food grains.

Khan and Qasim (1996)
Money supply and wheat support prices showed positive
relation with food price inflation and agriculture output was
negatively cointegrated with food price inflation.
 Khan and Schimimelpfenning (2006)
Found that broad money growth and private sector credit growth
were the key variables of inflation in Pakistan. Support prices
influenced inflation only in short run.
 Hasan et al. (2005)
concluded that supply shocks (production of agricultural goods)
have negative impact on food price inflation. Impacts of support
prices of wheat and expectations were positive and highly
significant on food price inflation. Money supply showed an
insignificant impact on agriculture food prices
 Lorie and Khan (2006)
Concluded that there is only a weak evidence of the existence of
long run co integration between domestic prices, international
prices and support prices for key agricultural goods in Pakistan.
 Dorosh and Salam (2006)
There is little effect of increasing procurement prices from
government on overall prices. In recent years, production short
falls, particularly in 2004, and hoarding are the major reasons for
price increases.
MODEL SPECIFICATION
 Economic literature on inflation provides some inflation models
that incorporate the demand and supply side factors (Hassan et
al., 1995; Khan and Qasim, 1996; Callen and Chang, 1999;
Bokil and Schimmelfennig, 2005 and Khan and Schimmelfennig,
2006).
 Following Khan and Schimmelfennig (2006), the stylized hybrid
monetarists-structulists model given below is formulated to
capture the effect of certain demand and supply side factors of
food price inflation in Pakistan.
FPI t  f (FPI t-1 ,M2G t ,PGDPt ,ASPt ,FX t ,FM t )
The above quation can be rewritten for estimation purposes as follows:
FPIt  0  1FPIt-1   2 M2G t  3PGDPt   4 ASPt
5FX t  6 FM t   t
t= 1, 2, 3, …., 37.
(time period ranging from 1972-2008)
FPIt= Food Price Inflation (CPI food as proxy of Food Price Inflation)
in time t
FPIt-1= one year lag of FPIt(as proxy of inflation expectations)
M2GRt= Growth Rate of Money Supply (M2) in time t
PGDPt= Per Capita GDP(in Pak rupees) in time t
ASPt= Agriculture Support Price (rupees/40kg of wheat) in time t
FXt= Food Export (as percentage of merchandise export) in time t
FMt= Food Import (as percentage of merchandise imports) in time t.
ECONOMETRIC METHODOLOGY
 Stationarity and Non-stationarity
 A stationary series is time invariant and fulfills the properties of
‘constancy doctrine’ i.e. constant mean and constant variance
and co-variance. In contrast, a non-stationary series violates one
or more properties of ‘constancy doctrine’.
 Augmented Dickey-Fuller test was proposed by Dickey and
Fuller (1979, 1981). It is widely used in economic literature to
investigate the stationarity of a time series data. Dickey and
Fuller (1979, 1981) have tabulated critical values for tδ which
are called ‘τ (tau) statistics’. Dickey and Fuller unit root test can
be applied under following two steps.
The Augmented Dickey-Fuller (ADF) Test
 Step 1, OLS is regressed on the following equation and save
the usual tδ values.
q
X t     t1   X t 1    j X t  j  t
j 1
 Step 2
The existence of unit root is decided on the basis of following
hypothesis;
H0 : for non-stationary if tδ≥ τ
Ha : for stationarity if tδ < τ
Johansen Co-integration Test
 Engle and Granger (1987) method finds out only one co-
integrating vector through two step estimation approach.
 While on the other hand, number of vectors can be found using
maximum likelihood testing procedure suggested by Johansen
(1988) and Johansen and Juselius (1990) in the Vector
Autoregressive (VAR) representation.
DATA SOURCES
Annual data from 1972 to 2008
Variables
Sources
CPI food (FPI)
Various issues of
Pakistan Economic
Agricultural support prices (ASP) Survey
Per capita gross domestic
product (PGDP)
Growth rate of money supply
(M2G),
Food exports (FX)
Food imports (FM)
World Development
Indicators (WDI)
online database by
World Bank (2009).
Augmented Dickey-Fuller (ADF) Test at 1st Difference
Variables
Trend & Intercept
Prob. Values
FPIt
-4.0928*
0.0156
M2Gt
-7.8567**
0.0000
PGDPt
-3.4095*
0.0173
ASPt
-3.7743*
0.0302
FXt
-8.2416**
0.0000
FMt
-6.0840**
0.0000
Note: * represents significant level at 1%.
** represent significant level at 5%.
VAR Lag Order Selection Criteria
Lag
AIC
SC
HQ
0
53.61601
44.30009*
44.46346
53.88264
46.16651*
47.92966
53.70805
44.94438*
45.65999
1
2
* Indicates lag order selected by the criterion
AIC: Akaike information criterion
SC: Schwarz information criterion
HQ: Hannan-Quinn information criterion
CO-INTEGARTION AMONG THE VARIABLES
 Same order of integration one I(1)
 Johansen co-integration
 Maximum Eigen Statistics
 Trace Statistics
Unrestricted Co-integration Rank Test (Trace)
H0
H1
Trace Statistics
0.05 Critical
Value
Prob.
r = 0*
r≥1
141.9786
95.75366
0.0000
r ≤ 1*
r≥2
82.89489
69.81889
0.0032
r≤2
r≥3
45.08015
47.85613
0.0891
r≤3
r≥4
18.41380
29.79707
0.5356
Unrestricted Co-integration Rank Test (Maximum Eigen value)
H0
H1
Max-Eigen
Statistics
0.05 Critical
Value
Prob.
r = 0*
r≥1
59.08367
40.07757
0.0001
r ≤ 1*
r≥2
37.81475
33.87687
0.0161
r≤2
r≥3
26.66635
27.58434
0.0652
r≤3
r≥4
12.69969
21.13162
0.4803
* Denotes rejection of the null hypothesis at the 0.05 level
Long Run Relationships
Dependent Variable = FPIt
Variable
Coefficient
T-Statistic
Prob-Value
Constant
-44.90991
-4.941833
0.0000
FPIt-1
0.735522
15.78609
0.0000
M2Gt
0.073152
1.499076
0.1447
PGDPt
0.001740
5.343473
0.0000
ASPt
0.055197
4.131034
0.0003
FXt
0.479935
3.675908
0.0010
FMt
0.272316
2.384839
0.0238
R2= 0.9986
Adj-R2 = 0.9984
F-Statistic= 3656.589
Prob(F-statistic)= 0.0000
Durbin-Watson
= 2.1329
Short Run Relationships
Dependent Variable = FPIt
Variable
Coefficient
T-Statistic
Prob-Value
Constant
-0.163500
-0.219200
0.8284
FPIt-1
0.800563
3.808210
0.0009
ΔM2Gt
0.059029
1.530154
0.1396
ΔPGDPt
0.001114
1.477726
0.1530
ΔPGDPt-1
0.000463
0.536597
0.5967
ΔASPt
0.058287
4.446252
0.0002
ΔASPt-1
-0.006688
-0.219333
0.8283
ΔFXt
0.354770
2.831904
0.0094
ΔFXt-1
0.134124
1.919740
0.0674
ΔFMt
0.275443
1.794954
0.0858
ΔFMt-1
0.009114
0.071144
0.9439
ECTt-1
-0.991143
-3.614136
0.0015
R2= 0.915113
Adj-R2 = 0.874
F-Statistic= 22.54085
Prob(F-statistic)= 0.0000
Durbin-Watson
= 2.092
Diagnostic Tests
Normality Test(JarqueBera Statistics)
Jarque-Bera Statistics
= 1.5011
Probability = 0.4721
Serial Correlation
(Breush-Godfrey Serial
Correlation LM Test)
F-statistics = 0.1859
Probability = 0.6696
ARCH Test
(Autoregressive
Heteroskedasticity Test)
F-statistics = 0.0147
Probability = 0.9044
Heteroskedasticity Test
(White Heteroskedasticity F-statistics = 1.4383
Test)
Probability = 0.3075
Model Specification Test
(Ramsey RESET Test)
Probability = 0.3744
F-statistics = 1.4383
Plot of Cumulative Sum of Recursive Residuals
15
10
5
0
-5
-10
-15
86
88
90
92
94
CUSUM
96
98
00
02
04
06
08
5% Significance
The straight lines represent critical bounds at 5 percent significance level.
Plot of Cumulative Sum of Squares of Recursive Residuals
1.6
1.2
0.8
0.4
0.0
-0.4
86
88
90
92
94
96
98
00
02
04
06
08
The straight lines represent critical bounds at 5 percent significance level.
CONCLUSION
 In Pakistan, food inflation remained 9.9 % on average
during the study period (1972-2008), some time as
high as 34.7 % in 1974 and 26.6 % in 2008-09.
 First of all, stationarity of time series was checked by
using Augmented Dickey-Fuller (ADF) unit root test.
Results of ADF proved that all the variables were nonstationary at level and became stationary at their first
differences at 5% level of significance.
CONCLUSION
 As the variables had same order of integration,
therefore Johansen co-integration was applied to
find the long-run relationship. Both statistics
(Maximum Eigen statistics and Trace statistics )
confirmed the existence of co-integration and same
number (two) of co-integrating vectors.
 Long run coefficients showed that the impact of all
independent variables on food price inflation was
positive and statistically significant except money
supply growth. All the coefficients had expected
positive signs.
CONCLUSION
 On
the basis of empirical results we may
conclude that food price inflation is not a
monetary phenomenon in Pakistan. While the
supply side factors or structural factors have
dominant role in determining the food prices.
 In the short run, only inflation expectations,
support prices and food exports affected the food
price inflation. The negative value of coefficient of
ECTt-1, which is (-0.9), indicated the very high
speed of convergence towards equilibrium.
POLICY IMPLECATIONS
 Inflation expectations
 Continuity and consistency in government’s economic
policies
 Strong policy statements and actions will help to dampen
inflationary expectations
 Support prices
 Government should pursue a moderate policy in raising
support prices to slow down the inflationary pressures and
maintain the reasonable production level of food grains
 Government may provide subsidies on inputs as on
fertilizers, pesticides, diesel and electricity
 Government should also encourage and support farmers to
adopt modern technology for higher production with lower
production cost.
 Economic growth
 Proper policy for agriculture sector to fill the output gap
 Credit facilities should be provided through formal and informal
channel.
 Improve infrastructure, agriculture markets and land ownership system
 Modern technology should be introduced to improve the production of
food grains, meat, poultry and dairy products
 Growth in Money Supply
 Government should encourage the expansion in private sector credit,
especially towards the agricultural and its related sectors
 There should be the availability and easy access of loans for all farmers
for all types of their needs such as expenditure on the use of modern
technology, inputs, marketing and storage facilities
 Increase in public expenditures on the provision of infrastructure for
rural areas will also be helpful for optimal utilization of the potential of
agriculture sector
 Imports of food
 We need to exploit our unrealized yield potential in production of food
items as God has gifted us with all necessary resources.
 Sound agriculture development strategies and result oriented agricultural
policies should be adopted by the government to produce foods in the
country.
 Exports of food
 Government should ban the exports of food items until they are over
and above the domestic needs.
 For price stability in the country, buffer stocks of essential food items
like wheat, sugar and pulses should be maintained.
 There should be maximum control on smuggling of wheat, rice and
live stock to neighboring countries through the coordination between
all the stake holders
Thanks