JINNAH UNIVERSITY FOR WOMEN

THE DEPARTMENT OF ECONOMICS

NAME Nida Nasir, Aniqa Saba, Rakhshanda Mukhtar

CLASS & SEMESTER M.A (P)- SECOND

SUBJECT TITLE INTERMEDIATE MACROECONOMICS

SUBJECT CODE 5192

DATE OF SUBMISSION 26th, October,2015

SUBMITTED TO Ms. Nighat Moin

MARKS OBTAINED /20

GRADE

TEACHER’S SIGNATURE

1

SERIAL

NUMBER

CONTENTS PAGE

NUMBER

1 EXECUTIVE SUMMARY 3

2 INTRODUCTION 4

3 ANALYSIS

Inflation and Money Supple

Inflation trends in Pakistan

Price Indices In Pakistan

Inflationary factors in Pakistan

Rate of Inflation (2000-2010) and its analysis

Recommendations

5

4 CONCLUSION 13

5 REFERENCE LIST 14

EXECUTIVE SUMMARY

2

This report provides an analysis of Inflationary trends in Pakistan from the fiscal year 2000 to 2010. Method of findings includes the official site of Economic survey of Pakistan. This report draws attention towards the fluctuations taking place in the prices of commodities, its impact on the economy’s growth. Inflationary expectations are to be checked to arrest increasing trend of inflation through prudent combination of fiscal and monetary policies.

Price stability remained the priority of the government. The economy has experienced bouts of growth and stable inflation but sustainable performance has remained largely elusive. An unprecedented global economic crisis together with escalating energy shortages and worsening security conditions in the domestic economy in recent years has not helped the situation either.

Thus through this report, we have analysed the data i.e. inflationary trends from 2000-2010 and gave recommendations considering the problems that have its deep root in Pakistan.

INTRODUCTION

3

In this assignment, we are bound to discuss about the “Inflation” in Pakistan with respect to 10 years data. Inflation refers to a rise in prices that causes the purchasing power of a nation to fall. Inflation is a normal economic development as long as the annual percentage remains low; once the percentage rises over a pre-determined level, it is considered an inflation crisis. The term "inflation" once referred to increases in the money supply (monetary inflation); however, economic debates about the relationship between money supply and price levels have led to its primary use today in describing price inflation. Inflation can also be described as a decline in the real value of money a loss of purchasing power in the medium of exchange which is also the monetary unit of account. When the general price level rises, each unit of currency buys fewer goods and services. A chief measure of general price-level inflation is the general inflation rate, which is the percentage change in a general price index, normally the Consumer Price Index, over time. Inflation can cause adverse effects on the economy. For example, uncertainty about future inflation may discourage investment and saving. High inflation may lead to shortages of goods if consumers begin hoarding out of concern that prices will increase in the future. Economists generally agree that high rates of inflation and hyperinflation are caused by an excessive growth of the money supply. Views on which factors determine low to moderate rates of inflation are more varied. Low or moderate inflation may be attributed to fluctuations in real demand for goods and services, or changes in available supplies such as during scarcities, as well as to growth in the money supply. However, the consensus view is that a long sustained period of inflation is caused by money supply growing faster than the rate of economic growth. Today, most economists favor a low steady rate of inflation. Low (as opposed to zero or negative) inflation may reduce the severity of economic recessions by enabling the labor market to adjust more quickly in a downturn, and reducing the risk that a liquidity trap prevents monetary policy from stabilizing the economy. The task of keeping the rate of inflation low and stable is usually given to monetary authorities. Generally, these monetary authorities are the central banks that control the size of the money supply through the setting of interest rates, through open market operations, and through the setting of banking reserve requirements.

Government authorities of Pakistan has always given a great importance to these two factors in the role of economy development, our economy remained low-inflationary since three decades after independence than it crossed its single digit inflation rate in 1970’s but reduced to single digit inflation in 1990’s because of the affect of international reserves on money supply and flexible exchange rate was also helpful in this regard.

ANALYSIS

4

Pakistan is an under developed country and it tried its best to develop it while money supply and inflation both are most important aspects of its economy and requires deepest attention from authorities. Different writers/authors give their views regarding these important issues of a country’s economy in different periods of time. Mostly they all agreed about these issues of money supply and inflation that money supply is that amount of money which circulates in an economy while inflation is describe as a persistent rise in price level in a country. They both correlated with each other in such a way that any change in money supply brings change in inflation rate and vice versa.

During the first seven years, i.e. from 1990 – 97 it remained persisted as an average at 11.4% due to lower investment and slower growth, increase in prices of food items, raw materials, inflationary expectations, increase in direct taxes, excess money supply, supply shocks, damage to crops due to unexpected dry weather, heavy rains, floods and etc while the efforts were made to keep money supply close to the growth of GDP and moderate the currency depreciation. But monetary policy was geared in coordination with achievement of twin objectives of macroeconomic stability with sustained economic growth and determining interest rate structure by free market forces. The rate of inflation declined in 1998 to 7.8%. Further it declined to 5.5% in 1999. Moreover in 2000 it was too much lower i.e. 3.4%. Most important causes for declining of inflation rate were the growth of money supply to some specific extant i.e. higher agricultural growth, easy supply and depressed international market.

The lower inflation rate more declined to 3.1% in 2002 – 04 but the rate than rose to 4.4% in 2006 and in 2007 rate of inflation reaches too much level, i.e. 9.3% against 4.4% in the previous year i.e. 2006. The factors for this rise in inflationary trend are the same i.e. due to supply shocks, demand pressures, rising level of incomes. To control the inflationary rate and to bring it with respect to the adequate money supply govt. took various measures. For the purpose SBP tightened its monetary policy from an easy monetary policy to strict policy. Lending rates has risen to 152 basis points and thus controlling the liquidity amount in this system.

Our economy is considered as an under develop country however efforts are making to move its economy on the road of development. Our per capita income clearly shows the economic conditions of our country which is much more less than the other develops countries. Our per capita income which was 479 dollar per annum raised to 736 US$ in the financial year 2009 -10, still it is not compatible to the develop countries. In spite of increasing population in Pakistan, literacy rate is much lower although government of Pakistan is much aware of the importance of education. It has introduced several education programs still it is only 54% in Pakistan. Expenditures made for increasing literacy rate is 2.5 of GNP which should be the minimum of 4% of GNP.

INFLATION AND MONEY SUPPLY:

Pakistan came into being on 14th August 1947 as an independent state but after it’sindependence it has to face a lot of hurdles in its way of development as all the sectors of economy whether they relate to macro level or micro level were in bad conditions and needed to be inquired by authorities. Even at that time inflation rate and money supply were two indicators showing economic growth. But government authorities

5

control this evil from its deep roots i.e. inflation, very carefully that’s why Pakistan has been a low inflationary country from its independence up till three decades onwards.Rate of inflation as measured by an increase in WPI averaged 2.6% during 1960’scomponents of WPI, i.e. food, raw materials, manufactures and the fuel and lubricants also grew by an average rate rending from 2.0% to 3.4% per annum during the era of 1960’s. Rate of inflation crossed single-digit threshold during 1970’s. WPI and its components increased at an average rate ranging from 12% to 18%. The double-digit inflation during 1970’s has been the result of two major oil shocks, a massive devaluation of currency and devastating floods destroying agricultural crops. Pakistan returned to the fold of single digit inflation during 1980’s. Inflation is a monetary phenomenon. Government expenditures played an important role in raising economy’s output which is also a source of inflation because govt. is forced to finance resulting from non commodity producing expenditure such as transfer payment, food subsidy, and greater participation in social services since government expenditure had significant impact on Y affects the demand for money depending on money market which resulted in increasing price level. During 1970’s effect of international reserve on money supply was higher. The reason was that during flexible exchange rate system government could depreciate the currency besides changing the foreign reserves to avoid balance of payment deficits. The depreciation would prevent a further decrease in foreign reserves. So the contribution of foreign reserve is higher.

INFLATION TRENDS IN PAKISTAN:

Govt. has made great efforts in making and following twin objectives of improving thecountry’s macroeconomic environment over the last six years past

Another important cause of recent higher inflationary rate is also the phenomenal rise in aggregate demand in the economy on one side and economy get supply shocks on the other side. The most important cause of inflation which impacted price level for the fiscal year 2010 included a great increase in international oil price combined with the unprecedented rise in world price of commodities due to demand from China. These two factors/causes are most important causes which give rise to inflationary pressure in Pakistan. Impact of inflation on economy is most adverse and disproportionate effect on the poor and rich segments of society as well as its wider effects on purchasing power of fixed-income group govt. of Pakistan give great response to this higher level of inflation in the sense that:It bring in its notice about domestic stocks of key commodities and prices of these commodities were adopted because of which it was easy for government to respond in a timely manner to the shortages of important commodities by importing substantial quantities of wheat and other essential commodities.

PRICE INDICES IN PAKISTAN:

In Pakistan four basis indices are published use to measure growth of inflation in Pakistan. These are:

Consumer price index (CPI)

6

Sensitive Price Index (SPI) Whole sale price index (WPI) and GDP deflator

 

The CPI reflects roughly the cost of living in the urban areas. The Sensitive Price Indicator (SPI) is used to assess the price movements of

essential commodities at short intervals so as to review the price situation in the country.

The WPI is used to measure the price movement of selected items in the primary and wholesale markets.

GDP deflator is an index of the prices of goods and services in which each is weighted to represent its importance in the gross domestic product. It allows changes in money value and real output in GDP to be distinguished.

In Pakistan, the main focus is placed on the CPI as a measure of inflation as it is more representative with a wider coverage.

INFLATIONARY FACTORS IN PAKISTAN:

Several supply and demand factors could be responsible for this surge in inflation.

SUPPLY-SIDE SHOCKS It can cause large fluctuations in food and oil prices, effects of which on overall inflation, at times, can be so excessive that these cannot be countered through demand management, including monetary policy.

INCREASED DOMESTIC DEMAND First, increased domestic demand created an output gap, putting upward pressure on prices. Growth in private consumption on the average remained over 10 per cent between FY04 and FY06, depicting signs of demand side pressures on price level. The relationship between growth and inflation depends on the state of the economy. High growth, without an increase in inflation, is possible if the productive capacity or potential output of the economy is growing enough to keep pace with demand. This is also possible if the actual output is below the potential output and there is sufficient spare capacity available to cope up with the demand pressures. When the actual output catches up with the potential output, there remains no spare capacity and the economy is working at full employment level, any further gain in growth comes at the cost of rising inflation. If demand continues to grow at this stage, and the productive capacity does not expand, there is a serious threat of rapid inflation in the long run without any additional growth in the output. A prolonged phase of rising inflation in such a case can have severe consequences for the economy.

INCREASE IN NET IMPORTS Second, the growing gap between domestic demand and production was filled by a sharp increase in net imports, which grew by above 40 per cent in FY05 and by 24 per

7

cent in FY06. As compared to imports, exports increased by only around 10 per cent in FY05 and by 13 per cent in FY06. This resulted in a record trade deficit.

RISING TRADE DEFICIT The expectations effect is very important since there is a danger that the current high rate of inflation can get locked into expectations of inflation. People expect higher salaries to compensate for expected increase in prices, speculation in asset prices increases, credit meant for manufacturing sector diverts to real estate and stock markets, and hoarders, profit and rent seekers become active in expectation of high price in the future. All this can have devastating effect for the prices.

FISCAL POLICY REMAINED EXPANSIONARY Third, fiscal policy has remained expansionary in the last few years. Expansionary fiscal policy fuels domestic demand and puts pressure on the current account deficit. It widens the investment-saving gap, which has to be financed externally. Financing of fiscal deficit through money creation adds to inflationary pressures. Increased government borrowing from central bank can have serious consequences for general price level.

EXPANSIONARY MONETARY POLICY Fourth, the expansionary monetary policy- high growth in money supply and loose credit policy- was believed to be contributing to high inflation. Although expansion of credit is usual in expanding economies, excessive credit growth can have adverse effects on real variables.

RISING IMPORT PRICES Rising import prices are also considered an important factor for inflation. Exchange rate, if depreciating can also put upward pressure on price level. Increase in prices of goods, such as petrol, raw material etc makes our imports costlier, impacting on cost of production. INDIRECT TAXESSimilarly, indirect taxes are also blamed as the main cause of inflation. The indirect taxes, such as sales tax and excise duties raise the prices of consumer goods. This creates inflationary pressure. On the other hand, direct taxes reduce the take-home income and have anti-inflationary effect. A substantial increase in support price of wheat is estimated to have an inflationary effect on consumer prices, particularly food prices. This effect is due to the fact that wheat and wheat-related products account for 5.1 per cent of the CPI basket.

INCREASE IN VELOCITY OF MONEY:

According to Fisher’s Quantity Theory of Money, if there is an increase in the velocity of circulation of money it also leads to inflation.

NON-PRODUCTIVE EXPENDITURES:

Government of Pakistan has to make a lot of non-productive expenditures like defense etc. Such non-productive expenditures lead to wastage of economy’s precious resources and also lead to inflation.

8

CORRUPTION AND BLACK MONEY:

Corruption and black money leads to increase in aggregate demand, which is cause

of inflation. These evils increase aggregate demand and import volume.

FOREIGN REMITTANCES:

Increase in foreign remittances is increasing the money supply in our country.

Increase in money supply leads to inflation.

POPULATION:

Population of Pakistan is increasing day by day. Increasing population is demanding

more and it creates inflation.

RATE OF INFLATION DURING 2000-2010:

The sustained and significant reduction in inflation rate observed during last three years and it was the key achievements of Pakistan. During the first seven years of 90’s era the average annual inflation rate, measured on CPI index, remained in the double digit (11.4).The inflation rate had come down to 7.8 percent at the end 2006-07 but has since steadily risen to 10.3% over the period July- April 2007-08. Inflation had been contained during the period of 2000-07 despite tremendous growth through a combination of tight monetary policy and the resolving of several supply bottlenecks. Despite these measures taken by the government over the last couple of years, inflation has steadily increased this past fiscal year due to soaring international food and energy prices. In 2008-09, Inflation accelerated at a rapid pace mainly because of rising food prices; a weaker rupee/dollar exchange rate; the gradual withdrawal of subsidies on gas, electricity and petroleum; the imposition of custom duty on the imports of various items; and an upward revision in the support price of wheat and sugarcane crops.

Poor fiscal management was the major reason in monetization of large fiscal deficits, declining economic growth causing supply shocks of essential items, excessive reliance on indirect taxes for resources mobilization, frequent downward adjustment of rupee value were some important factors responsible for the persistence of double-digit inflation during 2009 - 2010.

9

Food and non food inflation followed the overall inflationary patterns and declined to a single digit level. A against an average food inflation of 12.4% during 2009-10, it declined to 7.6% in 2009-10 and further to 5.9% in 2008-09. Similarly, non food inflation declined to 8.0% and 5.6% respectively from an average of 11.0% during the same period. Again this rate of inflation declined to 3.4% in 2010, during this period food has remained the major driver of the inflation on the back of major supply disruptions owing to devastating floods as well as spike in imported fuel and food stuff prices.

All this growth of inflation in Pakistan from 2000-2010 is explained in the table below:

Year CPI WPI SPI GDP deflator2000-01 4.41 6.21 4.84 6.722001-02 3.54 2.08 3.37 2.492002-03 3.10 5.57 3.58 4.422003-04 4.57 7.91 6.83 7.742004-05 9.28 6.75 11.55 7.022005-06 7.92 10.10 7.02 10.492006-07 7.77 6.94 10.82 7.702007-08 12.00 16.64 16.81 16.212008-09 20.77 18.19 23.41 20.002009-10 11.73 12.63 13.32 11.942010-11 13.92 23.32 18.18 18.78

Source: Federal Bureau of Statistic

ANALYSIS OF INFLATION:

The analysis presented in the table shows the inflation from 2000-2010. Overall inflation rate during 1999-2000 was 3.4%. It was further reduced to 3.1% in 2002-03. Main cause for lower level of inflation has been achieved as a result of strict fiscal discipline, lower monetization of the budget deficit, an output recovery, a reduction in duties and taxes and appreciation of exchange rate. Although there is a growth in economy and inflation rate is higher at 4.6% in 2003-04, 7.9% in 2005-06, rose to 9.3% in 2006-07 due to the fact that in terms of generating inflation there was the phenomenal rise in aggregate demand in the economy compounded by supply shocks.

10

There was a great rise in international oil prices with an increase in the world prices of commodities due to the demand from china. An indication of the ‘china factor’ in determining world commodity prices can be had from the fact that during 2007, china accounted for 27% of world demand for steel, 31% of coal, 7.0% of global imports of petroleum. For much of 2009 10, given the backdrop of high – and rising – international‐ commodity prices, imports were unlikely to dampen domestic prices, except to the extent of excess pressure caused by shortfalls in domestic production. Massive floods swept through one-fifth of the country and caused massive damages to crops, livestock and infrastructure which resulted in sharp acceleration in the commodity price and spike in inflation. Among the various other factors of inflation, food inflation is major factor that indicates the presence of inflation to a higher or lower level. Conclusion regarding the impact of inflation shows that it has the most adverse and wider effects on the purchasing power of the fixed income group. It discourages savings and adversely affects decision making in investment. The poor, jobless and fixed salaried groups are the hardest hit. It also distorts income distribution. The overall effects of inflationary trend from 2000-10 is given below in a table:

YEARS OVERALL CPI FOOD INFLATION NON_FOOD INFLATION

2000-01 4.4 3.56 5.092001-02 3.5 2.44 4.282002-03 3.1 2.89 3.242003-04 4.6 6.01 3.622004-05 9.3 12.48 7.102005-06 7.9 6.92 8.632006-07 7.8 10.28 6.022007-08 12.0 17.65 7.902008-09 17.03 23.13 13.372009-10 10.10 12.93 8.26

Source: Federal Bureau of Statistics

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

2009-10

CPI

4.4 3.5 3.1 4.6 9.3 7.9 7.8 12 17.03 10.1

Food inflation

3.56 2.44 2.89 6.01 12.48 6.92 10.28 17.65 23.13 12.93

Non-food inflation

5.09 4.28 3.24 3.62 7.1 8.63 6.02 7.9 13.37 8.26

5

15

25

35

45

55

INFLATION TRENDS 2000-10

Pe

rce

ntage

po

ints

RECOMMENDATIONS TO OVERCOME INFLATION:

11

Our proposals to control inflation rate in Pakistan are mentioned as under:

To achieve macroeconomic balance. Develop agriculture sector. Improve coordination of monetary and fiscal policy. Strengthen regulatory bodies to break down monopoly. Promote industries in Pakistan. To make equitable distribution of wealth. Encourage saving and investment in people. Eradicate smuggling, hoarding etc. Reduce indirect taxes. Explore new energy sources i.e. constructing new dams etc.

12

CONCLUSION

Inflation is one of the obstacles on the way of development. In Pakistan, it has squeezed the major part of the population. In Pakistan, Inflation is one of the major problems with almost more than 11% inflation rate per anum this is the hardest in the world. According to economists an inflation rate of 2 – 3% is required for the development of the economy and proper growth of the economy, but if it exceeds from this limit, then it becomes a problem.

It needs to be controlled by strategic planning. Domestic production should be encouraged instead of imports; investments should be given preference in consumer goods instead of luxuries. Agriculture sector should be given subsidies, foreign investment should be attracted, and developed countries should be requested for financial and managerial assistance. And lastly a strong monitoring system should be established on different levels in order to have a sound evaluation of the process at every stage.

Inflation can be controlled by Monetary Measures (Credit Control, Demonetization of the currency, Issue of new currency), Fiscal Measures (Curtailment in unnecessary expenditures, Increase in rate of taxes, Increase in volume of savings, Anti inflationary budgetary policy, Increasing public debt policy) and Non-Monetary and Non Fiscal Measures (Increase in volume of production, Price control and rationing policy).

On the basis of above findings a low inflation of 2 to 3%is desirable. It can be achieved through curtailment of monetary expansion, lowering budget deficit, promoting efficiency by education and skill, enhancing agriculture production through research and credit availability, promoting national savings by offering positive rate of return on deposits and identifying profitable avenues of investment and revival of the economy by solving the problems of sick industrial units and quick and transparent privatization of public sector enterprises.

13

REFERENCE LIST

Main website: www.finance.gov.pk , chapter: 7 Economic Survey of Pakistan.

14