IN THE NAME OF ALLAH, THE MOST BENEFICIENT, THE MOST MERCIFUL

MUHAMMAD ABDULLAHDR. RUKHSANA KALIM

DETERMINANTS OF FOOD PRICE INFLATION IN PAKISTAN: AN EMPIRICAL

ANALYSIS

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)

INTRODUCTIONIt 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. StructuralistSunkel (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.

The above quation can be rewritten for estimation purposes as follows:

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.

t 0 1 t-1 2 t 3 t 4 t

5 t 6 t t

FPI FPI M2G PGDP ASP

FX FM

t t-1 t t t t tFPI f (FPI ,M2G ,PGDP ,ASP ,FX ,FM )

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.

Step 2

The existence of unit root is decided on the basis of following hypothesis;

H0 : for non-stationary if tδ≥ τHa : for stationarity if tδ < τ

1 11

q

t t j t j tj

X t X X

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 SurveyAgricultural support prices (ASP)

Per capita gross domestic product (PGDP) World Development

Indicators (WDI) online database by World Bank (2009).

Growth rate of money supply (M2G),

Food exports (FX)

Food imports (FM)

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  53.88264  53.70805 1 44.30009* 46.16651* 44.94438* 2 44.46346  47.92966  45.65999

* 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(Jarque-Bera 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 Test)

F-statistics = 1.4383 Probability = 0.3075

Model Specification Test

(Ramsey RESET Test) F-statistics = 1.4383 Probability = 0.3744

Plot of Cumulative Sum of Recursive Residuals

-15

-10

-5

0

5

10

15

86 88 90 92 94 96 98 00 02 04 06 08

CUSUM 5% Significance

The straight lines represent critical bounds at 5 percent significance level.

Plot of Cumulative Sum of Squares of Recursive Residuals

-0.4

0.0

0.4

0.8

1.2

1.6

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 non-stationary 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 IMPLECATIONSInflation expectations

Continuity and consistency in government’s economic policies

Strong policy statements and actions will help to dampen inflationary expectations

Support pricesGovernment 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