icobm-determinants of food price inflation in pakistan-1

8/13/2019 Icobm-Determinants of Food Price Inflation in Pakistan-1

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IN THE NAME OF ALLAH, THE MOST BENEFICIENT,

THE MOST MERCIFUL


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MUHAMMAD ABDULLAH

DR. RUKHSANA KALIM

DETERMINANTS OF FOOD PRICE INFLATION IN

PAKISTAN: AN EMPIRICAL ANALYSIS


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INTRODUCTION

In the recent years, food price inflation has risen very

sharply at global level. According to CommodityResearch 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 capitaincome, urbanization and change in dietary habits

are the main reasons of sharp increase in demand

and prices of some basic food items.


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INTRODUCTION

Because of higher food inflation households have tomake reductions in some areas of food consumptionleading to malnutrition.

Malnutrition results in productivity losses of up to 10percent of lifetime earnings and GDP losses of 2-3percent. (Alderman, 2005)

High inflation erodes the benefits of growth andleaves the poor worse off.

(Esterly and Ficsher, 2001)


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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 and2008-09 respectively. Moreover, food inflation

remained more than 10 percent on average from

1972 to 2009, in the whole history of (West)

Pakistan.


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Historical Inflationary Trends 1971-72 to 2008-09

(Annual percentage change, period average)

Years Overall CPI Food CPI

70s 13.3 13.8

80s 7.2 7.9

90s 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


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LITERATURE REVIEW

Two Schools of Thoughts (sources of inflation)1. Monetarist

Friedman (1968, 1970 and 1971), Schwartz (1973)

Demand-side factors (money supply, real moneybalances)

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 )


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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 showedpositive relation with food price inflation andagriculture output was negatively cointegratedwith food price inflation.


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Khan and Schimimelpfenning (2006)

Found that broad money growth and private sectorcredit growth were the key variables of inflation inPakistan. Support prices influenced inflation only inshort 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 andexpectations were positive and highly significant on

food price inflation. Money supply showed an

insignificant impact on agriculture food prices


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Lorie and Khan (2006)

Concluded that there is only a weak evidence of the

existence of long run co integration between domesticprices, international prices and support prices for keyagricultural goods in Pakistan.

Dorosh and Salam (2006)There is little effect of increasing procurement pricesfrom government on overall prices. In recent years,production short falls, particularly in 2004, andhoarding are the major reasons for price increases.


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MODEL SPECIFICATION

Economic literature on inflation provides someinflation 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), thestylized 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.


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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 tASPt=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 )


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ECONOMETRIC METHODOLOGY

Stationarity and Non-stationarity

A stationary series is time invariant and fulfills theproperties of constancydoctrinei.e. constant meanand constant variance and co-variance. In contrast,a non-stationary series violates one or moreproperties of constancydoctrine.

Augmented Dickey-Fuller test was proposed byDickey and Fuller (1979, 1981). It is widely used ineconomic literature to investigate the stationarity of

a time series data. Dickey and Fuller (1979, 1981)have tabulated critical values for twhich are called (tau) statistics. Dickey and Fuller unit root testcan be applied under following two steps.


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The Augmented Dickey-Fuller (ADF) Test

Step 1, OLS is regressed on the following equationand save the usual tvalues.

Step 2

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

H0:for non-stationary if t

Ha: for stationarity if t<

1 1

1

q

t t j t j t

j

X t X X


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Johansen Co-integration Test

Engle and Granger (1987) method finds out only oneco-integrating vector through two step estimationapproach.

While on the other hand, number of vectors can befound using maximum likelihood testing proceduresuggested by Johansen (1988) and Johansen andJuselius (1990) in the Vector Autoregressive (VAR)

representation.


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DATA SOURCES

Annual data from 1972 to 2008

Variables SourcesCPI 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)


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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%.


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VAR Lag Order Selection Criteria

Lag AIC SC HQ

0 53.61601 53.88264 53.708051 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 criterionHQ: Hannan-Quinn information criterion


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CO-INTEGARTION AMONG THE VARIABLES

Same order of integration one I(1) Johansen co-integration

Maximum Eigen Statistics

Trace Statistics


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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


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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


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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

M2Gt 0.059029 1.530154 0.1396

PGDPt 0.001114 1.477726 0.1530

PGDPt-1 0.000463 0.536597 0.5967ASPt 0.058287 4.446252 0.0002

ASPt-1 -0.006688 -0.219333 0.8283

FXt 0.354770 2.831904 0.0094

FXt-1 0.134124 1.919740 0.0674

FMt 0.275443 1.794954 0.0858

FMt-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


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Diagnostic Tests

Normal ity Test(Jarque-

Bera Statistics)Jarque-Bera Statistics

= 1.5011Probability = 0.4721

Serial Co rrelation

(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

Heteros kedast icity Test

(White HeteroskedasticityTest) F-statistics = 1.4383 Probability = 0.3075

Model Specif icat ion Test

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


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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.


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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.


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CONCLUSION

In Pakistan, food inflation remained 9.9 % on averageduring the study period (1972-2008), some time ashigh as 34.7 % in 1974 and 26.6 % in 2008-09.

First of all, stationarity of time series was checked byusing 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.


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CONCLUSION

As the variables had same order of integration,therefore Johansen co-integration was applied tofind the long-run relationship. Both statistics(Maximum Eigen statistics and Trace statistics )confirmed the existence of co-integration and samenumber (two) of co-integrating vectors.

Long run coefficients showed that the impact of allindependent variables on food price inflation was

positive and statistically significant except moneysupply growth. All the coefficients had expectedpositive signs.


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CONCLUSION

On the basis of empirical results we mayconclude that food price inflation is not amonetary phenomenon in Pakistan. While thesupply side factors or structural factors havedominant 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 ofECTt-1, which is (-0.9), indicated the very highspeed of convergence towards equilibrium.

POLICY IMPLECATIONS


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POLICY IMPLECATIONS

Inflation expectations Continuity and consistency in governments economic

policies

Strong policy statements and actions will help to dampeninflationary expectations

Support prices Government should pursue a moderate policy in raisingsupport prices to slow down the inflationary pressures andmaintain the reasonable production level of food grains

Government may provide subsidies on inputs as onfertilizers, pesticides, diesel and electricity

Government should also encourage and support farmers toadopt modern technology for higher production with lowerproduction cost.


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Economic growth

Proper policy for agriculture sector to fill the output gap

Credit facilities should be provided through formal andinformal channel.

Improve infrastructure, agriculture markets and landownership system

Modern technology should be introduced to improve theproduction of food grains, meat, poultry and dairy products


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Growth in Money Supply

Government should encourage the expansion in private

sector credit, especially towards the agricultural and itsrelated sectors

There should be the availability and easy access of loansfor all farmers for all types of their needs such asexpenditure 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 foroptimal utilization of the potential of agriculture sector


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Imports of food

We need to exploit our unrealized yield potential in production

of food items as God has gifted us with all necessaryresources.

Sound agriculture development strategies and result oriented

agricultural policies should be adopted by the government toproduce foods in the country.


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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


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hanks

icobm-determinants of food price inflation in pakistan-1

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