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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