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Inflation Causes in Pakistan
Inflation Causes in Pakistan
Chapter 1
1.1
1.1.1
1.1.2
1.2
1.2.1
1.3
1.3.1
1.3.2
1.4
1.4.1
1.4.2
1.4.3
1.4.4
1.4.5
1.5
1.5.1
1.5.2
1.5.3
1.6
1.7
1.8
1
4
4
5
5
5
6
6
8
9
10
11
11
11
12
13
13
14
18
21
21
22
23
Chapter 2
Literature Review
25
Chapter 3
3.1
3.2
3.3
3.4
3.5
Research Methodologies
Purpose Of The Study
Type Of Investigation
Study Setting
Time Horizon
Research Instruments
33
34
34
35
35
35
Chapter 4
37
Chapter 5
53
References
60
EXECUTIVE SUMMARY
Generally, monetary growth, public policy, administered prices, rise in the prices of
imported goods, inflationary expectations and output growth are termed as the
determinants of inflation in Pakistan. One group of economists considers inflation a
monetary phenomenon, while the other assigns more weight age to rise in administered
prices and increase in prices of imported goods as determinants of inflation.
Causes of Inflation
The GDP growth has a significant dampening effect on inflation. This sector recorded a
meager growth of 2.5 per cent per annum during last five years which is even lower than
3.0 per cent population growth rate. The effect of poor agriculture growth is also evident
from the fact that 'food group (weight 49.35 per cent), in CPI recorded 107 per cent
inflation from 1990-91 to May, 1997 as compared with over all inflation of 97.57 percent
and non- food inflation of 88.0 per cent during the same period. Prices, however,
increased soon after the government's announcement. Inflation in Pakistan is claimed to
be a monetary phenomena. Pakistan saw a very high rate of monetary growth between
1990-91 and 1995-96, averaging 18.8 per cent per annum. Inflationary Gap=monetary
growth-(real GDP growth +price inflation) The National Credit Consultative Council
(NCCC) has approved a monetary growth rate figure of 14 per cent for 1997-98.
Increases in the world price of imports in the world market and a 40 per cent
devaluation / depreciation in the Pakistan rupee from January 1991 to June 1997 fuelled
Consequences of inflation
Almost all targets, such as GDP growth, price inflation, bank borrowing, trade deficit,
budget deficit, are violated. A low saying rate in the country is also one of the causes of
rising inflation. In the wake of 14 per cent inflation and an average 10 per cent deposit
rates, depositors are getting negative real rates of return on their deposits. Trading further
raises the price level by manipulation of the market through hoarding and black
marketing by the rent seekers while production eases the upward pressure on price level
in an economy. Inflation expedites this trend further.
Devaluation is also one of the consequences of inflation. Due to double digit inflation
Pakistan has been caught in the vicious circle of devaluation (devaluation inflation loss of
competitiveness again devaluation).
DEDICATION
ACKNOWLEDGEMENTS
This study could not have been accomplished without the guidance and supervision of Dr.
Zafar Moeen Nasir who provide the timely assistance almost all the time during the
undertaking of my project. I am equally thankful to all the
departments/agencies/multilateral institutions for providing the relevant material and data
to prepare the project in right manner. I am thankful to my friends without their support
and guidance, I would have been in great difficulty. I sincerely hope that this study
though more objective but would contribute definitely in determining the cause and
effects of one of the major problem in economic sector.
CHAPTER 1
INTRODUCTION
The subject of price inflation has been a concern of wide importance for economists and
common economic agents during the past two decades. Various theories have been
put forward to explain continuing inflation all over the world. In Pakistan also the
subject of inflation has been the central issue in most of the studies on
macroeconomics. Various factors which have been considered in the literature as
strong forces in determining price inflation include monetary expansion, stagnation
of output, increasing import prices, increasing wage rates, sticky expectations (habit
persistence), etc. The evidence, however, does not fully support all these factors as
the causes of inflation. This is partly due to the controversial nature of the subject of
macroeconomics.
It may not be wrong to suggest that macroeconomics has been advanced to its present
form mainly due to hostile controversy among various schools. The other main reason for
the poor performance of empirical macroeconomic models in the study of price inflation
in our opinion is the inherent weakness of econometric techniques when applied to
aggregate time series data. But there is no denial to the fact that each step in research
adds to the existing knowledge.
This study is yet another attempt to identify the major sources of inflation in Pakistan.
Due to recent Gulf crises it has become all the more important to update our knowledge
on the inflationary process in Pakistan. While this study was in progress, the government
It has often been suggested that a stable macroeconomic environment promotes growth
by providing a more conducive environment for private investment. Being the key
component of a stable macroeconomic environment low and stable inflation assumes
greater importance. It is, therefore, essential that inflation rate be kept stable even when it
is low. Prices on the average can be rising, falling, or stable. Inflation is a process of
rising prices. Inflation rate is measured as the percentage change in the average level of
prices. Inflation rate rises and falls over the years but it rarely becomes negative. If the
inflation rate is negative, it means the average price level is falling which is not good for
the economy. A recent study suggests that some level of inflation is essential for
promoting growth and investment. In other words, there exists a threshold beyond which
inflation exerts a negative effect on growth. The threshold is lower for industrial than for
developing countries. Notwithstanding the existence of a threshold the goal of the
macroeconomic policy should be to bring inflation down to single digit and keep it there.
Several costs of high and variable inflation have been identified. These costs typically
arise from distortions in economic decision-making arising from high or variable
inflation rates and result in lower levels of output than would otherwise be the case. High
inflation is also a regressive and arbitrary tax, the burden of which is typically borne
disproportionately by those in fixed income group and poor. Maintaining low and stable
inflation should be seen as a necessary part of the poverty alleviation strategy. The key
Inflation rate is defined as the percentage growth rate of some measure of general (or
overall) price level prevailing in an economy between any two periods. In
macroeconomics context the general price level is supposed to represent the overall
picture of the prices of goods and services prevailing in an economy. A good measure of
general price level should be based on the prices of most of the important goods and
services. In Pakistan different measure of general price level are either directly available
or they can be easily constructed from the available data. The choice of an appropriate
general price level essentially depends on the purpose for which the price situation is
being studied. In the context of our present study we will be interested in the following
measures of general price level.
The wholesale price index is based on the wholesale prices of most of the important items
being consumed. This measure of general price level is a useful price indicator for
business community, in particular the wholesale traders.
This measure of general price level is based on the retail prices of most of the important
household consumption items. The consumer price index is useful to study changes in the
cost of living over time.
The implicit GNP price deflator based on some particular period is obtained by dividing
GNP at current prices by GNP at constant price level is the Paasche price index of all the
goods and services produced by a nation. Due to its broad coverage, the implicit GNP
price deflator is regarded as a comprehensive measure of general price level and is useful
to assess the over time changes in the unit value of aggregate output produced by a
nation.
The general price level measured by the implicit GNP price deflator is not suitable to
evaluate the over time changes in the cost of buying a fixed basket of goods and services
in an economy. The reason is that in the measurement of general price level through this
price deflator the price of exports, which are not consumed domestically, are also
included while the prices of imports, which are domestically consumed, are excluded. To
10
The unit value index of imports is the implicit deflator of the value of imports. This
overall measure of the prices of imports is useful to study changes in the imported
inflation in a country.
The monthly index of retail prices or RPI is the most widely reported measure, and
comprises the total cost of a representative basket of final goods and services. All
households are included, except pensioners, who are mainly dependent on state income,
and the wealthiest 4 per cent. Clearly those businesses whose target population includes
the 15 per cent of households that consist of retired people could be misled if they based
their calculations on the RPI alone!
11
The index is derived from the prices of around 600 items on a specific day month, and
weighted according to importance. Weights are revised annually, using sample data from
the Family Expenditure Survey, to reflect changing patterns of household consumption.
Published the following month, the RPI is not seasonally adjusted. Instead it is expressed
as a rate of increase on the same month a year earlier. A full understanding of the
underlying trends requires study of the contribution of the various components to the
aggregate outcome. In February 1991, for example, the price of many household goods,
such as footwear, actually fell, despite an RPI rise of 9 per cent. Marketers also need to
recognize that the published RPI informs customers expectations and perceptions of
price changes. During times of high inflation customers often perceive themselves to be
worse off and there is a marked tendency to trade down buying basics products, more
inferior goods and value for money promotions.
The index includes a wide cross-section of items, including housing costs. And therefore
is used by governments to determine the annual increase in index-linked benefits, such as
12
The RPI has become a matter of concern in recent years, since, unlike indexes in many
other industrialized countries, it may have overstated inflation, owing to the inclusion of
mortgage interest payments and the community charge. Sharp rises in these have caused
the RPI to rise above the so-called fundamental rate of inflation. By feeding into indexlinked payments, it will also raise prices by inflating government expenditure. With the
RPI making headlines in financial markets, it would be politically attractive for the
government to remove these elements. The difficulty of justifying the case that mortgage
payments do not reflect rises in housing costs has so far prevented this.
The index measures the charge in gross income to maintain the real living standards of
taxpayers on average earnings after allowing for changes in direct taxes and national
insurance contributions. The newly elected Conservative government in 1979 to put
downward pressure on wage demands as planned tax cuts were progressively introduced
it. Unfortunately for the government the need for tight budgets and sharp increases in
national insurance actually caused the TPI to rise, eclipsing its value in depressing
inflationary expectations.
13
Inflation assumes problem proportions when the general level of prices rises both
continuously and unpredictably. However, it is far from agreed that zero or even falling
prices are preferable. Prices fell between 1920 and 1934, yet this period was associated
with stagnation, unemployment and widespread poverty. In comparison, the period from
1952to 1967 was associated with historically rapid economic growth and near full
employment, despite inflation averaging 3-4 per cent.
The mild or creeping inflation appeared a small price to pay for such performance. It is
associated with growth held true in many countries, and its beneficial effects included:
Money illusions on behalf of workers made nominal wage payments appear more
than they were in real terms. Prices changed so slowly that compensating wage
climb did not occur.
The cost of living was rising but the standard of living was rising ever faster, as
earning easily outpaced prices. Varying level of pay settlement enabled structural
change to take place without any groups suffering actual pay cuts.
Capital was raised easily, since shares formed a hedge against inflation. Money
illusions over nominal interest rates also encourage savings.
14
Such inflation causes as arbitrary redistribution of income, from the weak to the strong,
the saver to the borrower and from the retired to that still in full employment. People on
fixed incomes suffer the greatest erosion, closely followed by those unable to keep pace
with its rise, owing to weak bargaining power. Nominal interest rates, for example, failed
to keep pace with prices through much of 1970s, are imposing on pensioners.
Debtors, such as mortgage-holders and the government, benefit from the process as the
real value of their debts evaporates. Inflation is taxation without representation, as
rising prices and incomes increases tax yields. Know as fiscal drag, this process literally
drags previously exempt low wage earners into the tax net. Since both the above
mechanisms make governments the major beneficiary from inflation, it should not be
assumed that they would consistently pledge themselves to its defeat.
15
Weakening confidence in money causes movement into inflationary hedges such as land
gold and fine arts, efforts and resources are therefore diverted into protecting wealth
rather than create it.
Business using historical cost accounting standards can be misled by paper profits. When
plant is for replacement, depreciation allowances will be inadequate. A machine tool
costing, say $10,000 with an expected life of 20 years would be normally depreciated at
$500 per annum. Annual inflation of 10 per cent would, however, cause such a fund to be
over $50,000 short at the time of replacement.
16
The extent to which domestic prices rises faster than international competitors also
produces problems. If he currency is part of fix exchange rate mechanism such as the
ERM, then a rising balance of payments deficits will force its value to the lower end of
the permitted range. The government would therefore be forced to raise interest rates and
deflate the economy and until differential inflation was squeezed out of the system. In
this respect the real problem is not the inflation itself but the economy pain suffered in
squeezing it out of the system.
Downward flexibility in the exchange rate has also proved unable to avoid this outcome.
Successive devaluations of the pound provided only short-term relief of business seeking
to compete at home and abroad. The falling pound, which made overseas manufactures
less competitive, also made imported foods, fuels, materials and other inputs more
expensive, feeding directly into domestic factory costs and wage demands. The outcome
was a wage-price-devaluation spiral, with shortening time spans between the spirals.
17
Inflation is often defined in reference to its causes. Too much money cashing too few
goods is one such example. There is, however, little agreement as to the precise cause of
the inflation, especially amongst economists. There major inflation theories will be
discussed below and the various strands from each will then be woven into a general
framework for understanding the process concerned.
This explanation derives from Keynesian analysis. The inflationary gap occurs when
aggregate spending plans (C +I + G + X M) exceed full employment output at current
prices. The pressure of this excess demand is unable to induce extra output, so prices rise
to ration out the available supply. Attempts to secure extra resources will suck in imports
and imports and bid up wage levels, fuelling further spending. If excess demand persists,
a price-wage spiral will result.
Phillips had identified a stable relationship between the pressure of demand and the rate
of change in money wages over the period 1861-1957. Given a trend productivity growth
of 2 to 2 percent, zero inflation would be achieved at 2- percent unemployment.
Attempts to operate the economy below this level would generate demand-pull inflation.
The Phillips curve predicted inflation very accurately up to 1966, but began to understate
it by 4-5 per cent up to 1969, and by over 10 per cent in the early 1970s.
18
This occurs when price rises originate in increased factor costs without excess demand
being present. It may be seen their real income to what proves to be unsupportable levels.
If pricing is based on a cost-plus formula, for example, higher costs will be automatically
reflected in price rises as business struggle to maintain profit margins. Such supply-sides
pressures may be expected to diminish rapidly if such rises result in sharply reduces
sales, output and factor employment. If, on the other hand, businesses and unions believe
the government is unwilling to contemplate the consequences of resisting cost push
pressure, then employers will condone inflationary settlements and pass them on in
higher prices.
The government would then have to accommodate the price increases by expanding
money supply and aggregate demand by the amount necessary to maintain sales at the
higher price level. Any government prepared to underwrite such a wage-price spiral will
ensure that little incentive will be provided for management to resist cost pressures.
19
Wage push
The primary engine here would be a struggle between labor and capital to achieve real
shares of output that are mutually inconsistent. While desired shares can sum to over 100
per cent of the cake, actual shares cannot. Thus as unions demand and obtain higher wage
settlements to raise their shares, businesses restore profitability by raising prices and
reducing the real value of the pay increases. This process can only be halted if one of the
following occurs:
A similar struggle over shares could equally arise between different wage groups. Key
wage groups achieving a wage increase justified by productivity gains may promote
comparability claims. If concede, these would raise final prices, eroding the value of the
rises obtained by the high productivity workers, and promoting compensating claims. A
rigid wage structure provides many such linkages, and could readily support a general
wage-wage spiral.
20
This arises when businesses seek to widen margins by raising output prices more than
the rise in input prices. The need to rebuild profitability after its heavy erosion in the
1970s led to profit push after 1982. Input prices were low, owing to falling primary
product prices and near constant unit labor costs as productivity improved sharply. Profit
push contributed to inflation through most of the remaining decade.
Tax push
This occurs when wage groups have real income targets. The effect of progressive
taxation and increases in tax rates is to make these unattainable, causing compensating
wage claims. The switch from direct to indirect taxation, as occurred in 1979, served to
raise the RPI by 3 percentage points, while government policies to cut borrowing by
reducing nationalized industry subsidies and raising council-housing rents and rates
have also caused above average rises in the RPI. The 1991 budget also shifted the
balance of taxation By raising VAT and excises to finance a cut in the community
charge.
21
Import push
Import account for over a fifth of total final expenditure, so any rise in their prices will
be reflected in domestic inflation after a lag. The international dimension to inflation is
very important in an open economy like Britains. Inflation is very much an international
problem, with industrial nations experiencing similar patterns. The causes of this
international inflation must be a large part of the explanation of British inflation, while
domestic factors can be examined to explain any divergence from the average. The
common factor in recent inflationary surges was oil-price shocks. This could be viewed
as OPEC in a struggle to increase its share of the world cake at the expense of oil
consumers. Accommodating this with an expansion in world money supply produced
inflation, while eroding the real value of OPEC gains. OPEC therefore responds with a
further round of price increases. These sharp and unanticipated rises and a generalized
impact on other costs and prices, as energy- users found themselves unable to reduce
their dependence in the short term.
Well placed in energy terms, the UK, however, fared much less well than importdependent competitors, making further explanation necessary. The downward float of
the pound in the early 1970s was one factor, since it caused import prices to rise sharply,
feeding into inflation and promoting compensating wage demand.
Cost-push pressures as outlined above were identified as explanation of the underprediction of inflation after 1970. Despite unemployment rising to 1 million (4 per cent),
22
MV=PT
Where:
M = supply of money,
P = price level
V = velocity of circulation of money
T = level of transactions.
23
Monetarist explained the breakdown of the Phillips curve by relating the rate change in
money wages to the expected rate of inflation. Expectations were seen as a part of an
error-learning process, in that they would be adjusted to the extent they had been proved
wrong in the past. The only way that the government could maintain unemployment
below the natural rate was its actual inflation exceeded expected inflation, thereby
reducing real wages to justify the extra jobs created.
Error learning meant that this could only be achieved at the expense of accelerating
inflation. In figure any attempt to reduce unemployment to Uf by expanding the money
supply causes an increase in money wages to W1. The anticipated inflation this produces
shifts the short-run Phillips curve to P2 as expectations adjust and compensating wage
demands rise to W2. To maintain employment at Uf, money supply must again increase,
and the process repeats but an accelerating rate shown as wage rises to W3. There is no
permanent trade-off a little less unemployment for a little more inflation. Instead the
acceleration would be unsustainable, ending in hyperinflation. Only with zero excess
demand is a steady inflation rate possible under this theory. On this analysis, then, curing
24
25
In this study I studied about the various factor that cause inflation and suggested the
ways that can be used to stop its effect.
Pakistans economy has faced many ups and downs since its independence. Some major
improvements came about during the reign of Ayub Khan. But those improvements were
short lived, and since then there have also been times when Pakistan had to face severe
sanctions imposed on it due to the nuclear tests in 1998. Therefore in order to completely
analyze the situation we need to consider all the major changes that took place within
these 50 years after independence with a major emphasis on the past 5 years situation.
Inflation rate has been at its lowest due to government policies, stable rupee and increase
in foreign reserves.
26
The basic objective of this study is to point out the basic point that is responsible for
inflation. In Pakistan inflation is increasing at very hg rate. Objectives are as under
Poverty Alleviation.
Gender development.
Enhance outreach.
Economic development.
The current research work has therefore aimed at gaining insight into the extent of
achieving of these objectives of a developing country like Pakistan.
27
The value or purchasing power of money refers to the amount of goods or services one
pound can buy. Inflation means the value of money is falling because prices keep rising.
The retail price index (RPI) is a monthly survey carried out by the government, which
measures price changes.
The rate of inflation is the percentage change in the RPI over the last twelve months.
Cost-push Inflation occurs when a firm passes on an increase in production costs to the
consumer.
Demand-pull inflation occurs when there is 'too much money chasing too few goods'
because the demand for current output exceeds supply.
28
Consumer Price Index (CPI) is a measure of price changes in consumer goods and
services such as gasoline, food, clothing, and automobiles. The CPI measures price
change from the perspective of the purchaser.
Producer Price Indexes (PPI) is a family of indexes that measure the average change
over time in selling prices by domestic producers of goods and services. PPIs measure
price change from the perspective of the seller.
29
CHAPTER 2
LITERATURE SURVEY
30
According to our knowledge the first study on inflation conducted in Pakistan is by Porter
(1961). This study deals with the trends of price level in Pakistan during 1950s. The
essential feature of the study is the explanation of inflation in the context of structural
elements. The author highlighted the importance of agricultural sector bottleneck as a
factor in determining the inflation rate in Pakistan where economy is heavily dependent
on agricultural sector and the banking system is not fully developed. Disagreeing with the
application of standard monetary theory in explaining inflationary process in Pakistan, he
argued that prices movements and the demand for real money balances in Pakistan
correspond with the trends in harvest. In case of harvest failure there is tendency among
many stockists to hold purchased cereal rather than money. Therefore the demand for the
real money balances decreases along with increase in price level. Furthermore, in case of
harvest failure producers reduce their surplus to the market by a larger proportion than
the decline in their output, which raises the portion of national income, consumed in the
non-monetized sector. This further reduces demand for real money balances for
transaction purpose.
31
After (1973) analyzed the causes of price inflation in Pakistan with the help of a few
linear regression equations estimated over the annual observations for 1959-60 to 197273. The regression equations contained the growth rate of money supply in the current
and previous years and the current level of GDP measured at constant prices as
explanatory variables in determining inflation rate measured alternatively by the growth
rates of wholesale price index and consumer price index. The author concluded that
demand factors played a major role in the inflationary process.
The most comprehensive study on inflation in Pakistan has been conducted by Mangla
(1981). With the help of regression analysis he tested four main hypotheses in his study,
namely the two-way causation hypothesis based on monetarists models, the imported
inflation hypothesis, the cost-push hypothesis and the dominant impulse hypothesis. The
study is based on annual observations over the period 1961-1979.
32
To test the import inflation hypothesis Mangla related domestic price changes to changes
in money supply, import prices and real output. He found that the changes in money
supply and import prices significantly affected the domestic inflation rate. He also
observed that the relative importance of monetary changes as compared to import prices
in explaining domestic inflation rate declined over time most probably due to increasing
degree of openness of the economy of Pakistan.
The cost-push hypothesis performed poorly in Manglas study as the effect of money
wages on price inflation was found to be statistically insignificant in most of his
estimated regression equations.
In the dominant impulse hypothesis Mangla suggested that fluctuation in aggregate price
level are dominant by four systematic impulses operating in the economy, the fiscal, the
33
Bilquees attempted two studies on inflation in Pakistan. In her first study Bilquees (1981)
applied the monetarists and structural models of inflation on Pakistan using annual data
for the period 1969-61 to 1977-78. According to monetarists model inflation results from
monetary expansion while according to structural model the real cause of inflation is low
output due to structural bottlenecks (constraints in agricultural sector, foreign exchange
and domestic resources, etc.). In her regression exercise Bilquees found inconclusive
results as signs of a number of estimated regression coefficients were contrary to the
theory. She concluded that both the models are capable of explaining price inflation but
not satisfactorily and, therefore exclusive reliance on either of the two models would
yield erroneous results.
In her second study Bilquees (1987) analyzed inflationary trends in Pakistan and
compared these with inflation in industrialized countries, non-oil producing developing
countries and the Asian region countries. She also discussed the available literature on
inflation in Pakistan.
The author pointed out that inflation rate during 1960s averaged around 3 percent except
for the year 1966-67 when the inflation rate reached its peak rates of sixties, that is, 9.27
34
While comparing inflation in Pakistan with that in other countries, the author found that
on the whole, the inflation rate in Pakistan has been higher than that in the Asian region
countries in particular during the period of high inflation, 1973-75. Pakistans inflation
rate moved fairly close to the average rate in the world and the industrial countries. On
the basis of this comparison she concluded that Pakistan has been significantly affected
by the inflationary trends in world.
35
The most recent study by Naqvi and Khan (1990), entirely based on the PIDE
Macroeconomic Model (1989), deals with the inflation phenomenon in Pakistan over the
period 1989-90 and 1990-91. According to their analysis inflation in Pakistan has been
caused by increase in money supply, slower growth in the commodity producing sectors
as compared to the services sector and increase in import prices. The authors found that
the considerable range of inflation was nit due to any domestic policy since 74 percent of
inflation in 1989-90 was exogenously given or predetermined (due to increase in import
prices or inflation in previous period). The fiscal factors, though significant determinants
of inflation, were less important in forming inflationary process as compared to the
import prices and the composition of GDP (the ratio of value added in the commodity
producing sectors to the value added in the services sector).
We concluded this section with the observation that there has been mixed evidence on the
process of price inflation in Pakistan. Various authors have applied different theories in
explaining inflation phenomenon in Pakistan. In general any signal theory could not
36
37
CHAPTER 3
RESEARCH METHODOLOGY
38
This study is descriptive in nature. Descriptive study is a study where we try to describe
certain characteristics of the existing phenomena on which interest centers. In this study I
studied about the factors causing inflation. This study was based on secondary data. It
will be of great help to students of economics and business studies.
There are generally three types of studies, which include; exploratory study, descriptive
study and hypothesis study. This piece of research has mainly employed descriptive
approach in general and the hypotheses have also been evaluated in the same manner. A
descriptive study is under taken in order to ascertain and to be able to describe the
characteristics of variables in a situation, the goal of a descriptive study is to describe the
relevant aspects of the phenomena of interest to the researcher from an individual and
organizational point of view and other relevant perspectives.
Hypotheses study are those which include the testing of the hypothesis to explain the
nature of certain relationships or to establish the differences among groups or the
independence of two or more groups or the independence of two or more factors in a
situation.
39
The study is based on secondary data because to conduct a primary survey time is so
limited. I have collecting data from government organization and taking help from
researches that have been already done.
It was on-shot or cross-sectional study. Cross sectional is a study in which data are
gathered just once, perhaps over the period of days or weeks or months. The time frame
of this study was 6 months but note that the researcher has given only two months to
conduct a survey and its interpretation.
Data can be collected in a variety of ways in different settings and from different sources.
Research instruments include face to face interviews, telephone interviews, computer
assisted interviews, questionnaires that are personally administered, sent through the mail
or electronically administered, observation of individuals and events with or without
videotaping or audio recording and a variety of other motivational techniques such as
projective tests
40
41
CHAPTER 4
42
Pakistan has sustained a double-digit inflation between 9.8 to 13.0 percent during the first
seven years of the 1990s. Not surprisingly, one of the critical macroeconomic issues in
Pakistans policy arena during those periods has been as to how to put inflation under
effective control. The persistence of a double-digit inflation along with large fiscal deficit
(7.0% of GDP) has been the major source of macroeconomic imbalances in the 1990s.
There has been a general agreement that lax fiscal management resulting in the excessive
growth in money supply, the supply side bottlenecks, the adjustment in government
administered prices, the imported inflation (pass through of exchange rate adjustment),
escalations in indirect taxes, and inflationary expectations have the major factors
responsible for the persistence of a double-digit inflation during most period of the 1990s.
Both food and non-food inflation contributed to the persistence of the double-digit
inflation. Food and non-food inflation averaged 12.2 percent and 10.7 percent,
respectively during the seven years of the 1990s [Table 4.2} Inflation slowed to an
43
44
45
Inflation averaged at 3.3 percent during July-April 2002-03. The low level of inflation in
the midst of 12.5 percent increase in money supply is the result of better supply situation
of essential commodities, appreciation of exchange rate, prudent fiscal management and
continued sterilization of monetary impact of massive foreign exchange inflows. Food
and non-food inflation have been estimated at 3.1 percent and 3.4 percent, respectively as
against 2.1 percent and 4.4 percent respectively in the corresponding period of last year
[See Table-4.3]. The higher increase in food inflation over the comparable period of last
year is attributable to increase in prices of wheat, wheat flour, rice basmati, meat, tea,
vegetable ghee and cooking oil. The increase in vegetable ghee and cooking oil is the
result of increase in international price of palm oil and imposition of GST on the local
manufacturing of ghee in the Federal Budget 2002-03. As shown in Table 4.4, out of 19
widely consumed daily items the prices of 9 items have declined in the range of 3.8
percent (Chicken Farm) to 51.5 percent (potato). At the same time, the prices of 10 items
have increased in the range of 2.7 percent (Fresh Milk) to 15.8 percent (tea). It may be
noted that prices of all the four types of pulses (Masur, Moong, Mash and Gram) have
declined because of increase in their production. Accordingly, the contribution of food
inflation in overall inflation is estimated at 38.1 percent in 2002-03 as against 25.1
percent last year.
46
47
48
49
The WPI, on average basis, increased by 6.1 percent during July-April, 2002-03. This
increase in WPI is significantly higher than the increase of 2.1 percent last year. To this
increase, maximum contribution was made by the fuel & lighting group (15.7 percent),
followed by raw material (9.4 percent), and manufacturing group (2.6 percent). The
larger increase in the index of fuel & lubricant at 15.7 percent against 3.5 percent last
year is mainly attributable to increase in prices of POL products. The increase in the
prices of raw material has mainly been due to the fact that price indices of certain
important items like cotton, cotton yarn, vegetable ghee etc. have increased at higher rate
during the current fiscal year than last year [See Table-4.6].
50
The SPI is used to capture the movement in prices of 53 essential items, consumed by the
urban households with income of Rs.3000-Rs.12000 per month. The increase in SPI
during the first ten months of the current fiscal year (July- April) 2002-03 is estimated at
3.7 percent against 3.2 percent last year mainly due to the increase in prices of some basic
food items such as wheat (7.8%), wheat flour (5.8%), rice basmati (9.2%), mutton
(13.8%), beef (13.7%), vegetable ghee (8.4%), cooking oil (10.5%) and tea (15.8%).
Much of the increase in prices of wheat is attributable to its lower production (-4.2%) in
2001-02. The increase in Meat prices is due to increasing demand and vegetable ghee is
due to imposition of GST on local manufacturing of ghee as well as substantial increase
in the international price of palm oil. However, prices of some basic food items like
sugar, pulses, red chilies, chicken (Farms), onion and potatoes have shown significant
decline up to the range of 52% on account of improved supply position of these items
[See Table-4.4 for details].
51
Price stabilization measures are important when there are unusual variations in the prices.
Presently, the government in commensurate with its policy of decontrol, deregulation and
liberalization, believes in tackling the inflationary pressures through economic measures
rather than formal price control. However, close vigilance is kept on unusual rise in
prices through weekly meetings of the Kitchen Items Committee, now called the
Sensitive Items Price Committee (SIPC) and through the weekly meetings of the ECC of
the Cabinet. Other measures in the realm of supply augmentation, reduction in import
duty to facilitate larger imports, improved marketing practices, timely distribution,
coordination with private sector and persuading traders/manufacturers to refrain from
unfair practices are undertaken to ensure price stability in the country.
The above analysis clearly suggests that the Government has succeeded in keeping
inflation not only low but it is much lower than the target (4.0%) for this fiscal year. The
increase in prices of daily consumable items has also remained low. In many cases the
prices of some essential items have fallen when compared with last year. In some cases
the price have increased as well. This is the normal practice in any economy. The whole
idea of the countrys monetary and fiscal policy is not to maintain negative inflation
(decline in general price level) but to keep inflation at low level. The government has
succeeded in keeping inflation low (3.3%) during the current fiscal year. Even in future,
inflation rate should remain within the range of 3 to 4 percent. Keeping inflation at low
level should be regarded as protecting the poor from inflation tax.
52
Despite several announcements during the 1990s by each of the last three elected
governments regarding reduction of inflation from double to single digits, there is no
evidence at present that in the coming years this dream will materialize. This can be
attributed primarily to the bleak economic Scenario prevailing in the country.
Several studies have been conducted to explore the causes of inflation during the 1990s.
Generally, monetary growth, public policy, administered prices, rise in the prices of
imported goods, inflationary expectations and output growth is termed as the
determinants of inflation in Pakistan. However, their actual contribution towards inflation
is debatable. One group of economists considers inflation a monetary phenomenon, while
the other assigns more weight age to rise in administered prices and increase in prices of
imported goods as determinants of inflation. Overall, host of factors from both the
demand and supply side are responsible for the recent price spiral in Pakistan. The
following is a brief review of the factors responsible for inflation during this period.
53
The GDP growth has a significant dampening effect on inflation. Pakistan's GDP has
grown at an average rate of more than 6 per cent per annum during the last decade.
During the first half of 1990, however, the growth rate remained at an average of 4 per
cent per annum which may be attributable to the transition of economy from greater
government role to private sector, inefficiency of public sector enterprises, lower
production in large scale manufacturing, poor agriculture sector performance and
distortion public policies. Most public sector enterprises have become inefficient and
have been incurring losses for several years. More than 4000 industrial units in the
private sector are 'sick' due to which performance of the manufacturing sector is poor for
the last few years and recorded a negative growth of 1.4 per cent this year. The
agricultural sector, which contributes 26 per cent to the GDP, also exhibited vulnerability
during the last five years' period. This sector recorded a meager growth of 2.5 per cent
per annum during last five years, which is even lower than 3.0 per cent population growth
rate. The effect of poor agriculture growth is also evident from the fact that 'food group
(weight 49.35 per cent), in CPI recorded 107 per cent inflation from 1990-99 to May,
1999 as compared with over all inflation of 97.57 percent and non- food inflation of 88.0
per cent during the same period. Furthermore, the country faced a severe wheat shortage
this year due to lower than targeted production of wheat in the country, delay in its import
and failure of responsible authorities in its prompt distribution in different areas of the
country.
54
55
Increases in the world price of imports in the world market and a 40 per cent
devaluation / depreciation in the Pakistan rupee from January 1995to June 1999 fuelled
inflation to unmanageable levels. Without removing the causes of devaluation, we are
lowering the value of our currency to make our commodities competitive. As devaluation
fuel inflation, it becomes necessary to devalue further to keep our market competitiveness
intact. This has put the Pakistani rupee in a devaluation spiral.
Large and persistent levels of trade and current account deficits due to stagnant exports
and high levels of imports are posing several implication for inflation. More than 60 per
cent of our exports consist of cotton and cotton-based products, which are facing
cutthroat competition in the world market. Our major imports are machinery, chemicals
and oil, which registered a faster growth in price in international market due to the
monopolies created by developed countries.
56
The ratio of indirect to total tax revenues in Pakistan is more than 70 percent. It has been
the practice of all governments from past to present to tap revenues from indirect taxes,
due to which inflation in the country has reached a very high level. The debt burden of
Pakistan is almost equal to GDP, which has made budget making a very unpleasant task
for the government every year. The government has to borrow to service the existing
debt. Due to this, the debt pool is inflating day by day. As getting unlimited funds from
abroad is not possible (although least inflationary in nature) the government has to resort
to note printing which fuels inflation severely. Borrowing from the banking and nonbanking sector also has its limitations. The government has to compete with the private
sector and offer attractive rates of return on its securities. The government is offering
more than a 17 per cent rate of return on its securities leaving banks in a liquidity crunch
and putting upward pressure on the lending rate to the private sector. In the wake of a
high lending rate the revival of the economy is looking difficult.
The percentage increase in the following food and beverages items in February 2004 over
February 2003 shows how difficult life has become for the poor:
Wheat (22 pc); wheat flour (18pc); milk fresh(3.8pc); curd(3.2pc);branded powdered
milk(9.7pc); loose powered milk(7.7pc); branded turmeric powder(47.3); bread
57
rusk(5.1);bread
tandori(18.3pc);
tea
prepared(6.8pc);
beef
with
58
During an inflationary period it becomes very difficult for the government to fulfill its
commitments of achieving macro economic targets. Almost all targets, such as GDP
growth, price inflation, bank borrowing, trade deficit, budget deficit, are violated. This
hurts the credibility of the government. Costs of development project and nondevelopment expenditure increase due to which the government needs more funds next
year by the amount of inflation to keep economic activity at the level of previous year.
A low saying rate in the country is also one of the causes of rising inflation. In the wake
of 14 per cent inflation and an average 10 per cent deposit rates, depositors are getting
negative real rates of return on their deposits. Income of the individuals is being diverted
from saving to consumption and non- productive channels like purchase of real estate and
conspicuous consumption leaving saving at a very low level of 11 per cent in the country.
A kind of rent seeking culture develops due to inflation where the businessman earns
lucrative profits by trading existing production. This provides a disincentive for him to be
involved in the production process. An entrepreneurial culture cannot develop in this
59
As inflation is a regressive tax on fixed and low-income groups, it can cause anxiety,
unrest and many other social problems in the country.
Dollarization, as defined by the ratio of foreign currency deposits total monetary assets
(M2), takes place due the decline in the value of domestic currency. This process never
reverses until or unless the value of the local currency is not restored as is evident from
the study of transitional economics of the socialist block and other developing countries.
Foreign currency deposits in Pakistan have reached the $ 9.4 billion mark since their
inception in 1992 to date acting as a hanging sword on the head of the government.
Inflation expedites this trend further.
As a result of inflation real money balances (M/P) decline and we need more money to
exchange the same quantity of goods and services. This puts pressure on the printing
press to print more and more currency notes to meet the requirement. This is the extra
cost attached to inflation.
60
61
62
CHAPTER 5
63
Conclusions
Consensus has developed among the economists that the inflation and output growth are
negatively correlated specially at the level of double digit inflation. An unclear trade-off
between inflation and unemployment at a very low level of inflation of 3 to 4 per cent is
also identified. On the basis of these findings a low inflation of 2-3 per cent 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
privatizations of public sector enterprises.
During the first seven months of the current financial year ending January 30, the
Federal Bureau of Statistics says inflation (consumer price index) was 3.38 per cent,
while the Sensitive Price Index, which covers largely food items, was 4.78 per cent and
the
wholesale
price
index
6.43
per
cent.
If the prevailing price push continues, as seems likely, the consumer price index may
cross the 4 per cent barrier soon and move to a far higher figure. And if the continuing
massive unemployment is aggravated by rising inflation, particularly of essential items,
the
hardships
of
the
people
can
be
enormous.
64
The fact that CPI inflation has risen by 4.31 per cent in February 2003 primarily owing
to increase in the items falling in food and beverages bring home a crucial point. That is
the effective inflation for the poor people who spend most of their income on food is
much higher than the nominal 4.31 per cent increase in CPI value during last month.
Food & beverages have more than 40 per cent weight in overall CPI consisting 374
items.
Recommendations
actions and other policy decisions ,by implying that whereas the SBP would keep overall
money supply in check the government would try to contain its borrowing from the SBP
that is very inflationary.
The government should check the price-hikes in wheat flour and cement and
steel, etc The government policy not allowing WAPDA and the KESC to go for an in
justified increase in power tariff is another example of what the government can do to
check inflation. Similarly, efforts to document the economy are going to contain rising
currency in circulation that is creating asset price bubbles in the economy pushing up the
price line.
65
Inflation in Pakistan is hard to control efficiently and quickly with out enhancement of
agricultural production. There is need to provide credit to small farmers. His weak
financial position and skill level prevent him from employing modern equipment and
inputs to his farm. It is no easy task for mall farmers in Pakistan to obtain credit. It is
66
Banks are unable to offer a positive real rate of return to depositors in Pakistan due to
huge intermediation costs and stuck up loans. Implementation of recently approved laws
by the parliament will help cure this situation. Process of privatization of the nationalized
commercial banks (NCBs) should be speeded up keeping in view the transparency of this
process.
As a long-term policy measure, human capital must be equipped with skill and
knowledge to enhance its productivity and efficiency, and ultimately tame inflation. The
standard of living and the level of education have a strong bearing on population growth
and other matters of social and economic well being. Autonomy granted to SBP is also a
right step towards financial soundness and restoration of the value of currency.
Performance of SBP hinges on the success of recovery drive, controlling monetary
expansion to public sector for budgetary support and reducing the lending rate by
lowering the intermediation cost of the banking system. Fiscal policy should be made
instead of monetary policy.
67
References
Usman Afridi And Asghar Qadir, 1982, Dual Sector Inflation In Pakistan
Syed Nawab Haider Naqvi And Ashfaque H. Khan, 1989, Inflation And Growth
An Analysis Of Recent Trends In Pakistan
68
69
70
References
Usman Afridi And Asghar Qadir, 1982, Dual Sector Inflation In Pakistan
Syed Nawab Haider Naqvi And Ashfaque H. Khan, 1989, Inflation And Growth
An Analysis Of Recent Trends In Pakistan
71