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According to official statistics, price inflation in
Pakistan, as measured by the consumer price index (CPI), remained on
average 11.1% per annum between 1990-91 and 1995-96 but more
than 20% as believed by most of the economists. Price inflation,
defined as the persistent rise in general price level in a country, may be
described as creeping, running or galloping depending on its pace of
rise in a country. Inflation in Pakistan has entered into the regime of
͚running inflation͛ intimating to the managers of the economy the
seriousness of unmanageable feature of macro-economics variables in
the country.

Several studies have been conducted to explore the causes of inflation

during the 1990͛s. 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. However, their actual contribution towards
inflation is debatable. One group of economists considers inflation a
monetary phenomenon, while the other assigns more weightage 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.


The GDP growth has a significant dampening
effect on inflation. Pakistan͛s GDP has grown at an average rate of
more than 6% per annum during the last decade. During the first half of
1990, however, the growth rate remained at an average of 4% per
annum which may be attributable to the transition of economy from
greater government role to the private sector, inefficiency of public
sector enterprises, lower production in large scale manufacturing, poor
agriculture sector performance and distortionary 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 ͚sick͛ due to which performance of the manufacturing
sector is poor for the last few years and recorded a negative growth of
1.4% this year. The agricultural sector, which contributes 26% to the
GDP also exhibited vulnerability during the last five years͛ period. This
sector recorded a meager growth of 2.5% per annum during last five
years which is even lower than 3.0% population growth rate. The effect
of poor agriculture growth is also evident from the fact that ͚food group
(weight 49.35%), in CPI recorded 107% inflation from 1990-91 to May,
1997 as compared with overall inflation of 97.57% and non-food
inflation of 88.0% 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.
As far as administered
prices are concerned the government increased the procurement price
of wheat, gram, rice, sugarcane, e.t.c. This year in the range of 10% to
40% to give impetus to the production of these crops. Actual quantities
of these crops will come into the market with the time lag of at least 6
months. Prices, however, increased soon after the government͛s
announcement. Distortionary public policy towards agriculture sector in
the past has put us into the situation that, Pakistan, an agricultural
country, is bound to import wheat, milk, cooking oil, pulses, meat e.t.c
to the tune of $2.0 billion annually. Solution of half of trade deficit
problem of the country hinges in self-sufficiency in agricultural
production. Similarly, the index of fuel, lighting and lubricants in CPI,
which comprises electricity gas and POL products increased 19% during
the year from end June, 96 to May, 97 and 98.59% from 1990-91 to
May 1997 which caused rise in cost of production and transportation
cost. One reason for rise in the prices of POL products in the country is
price-hike of POL in the international market determined by demand
and supply forces. The other one is the frequent devaluation of
domestic currency which is controllable by better economic
management in the country. Almost every increase in administered
prices adds more and more grieves, miseries and hardships to the
consumer life.

Increases in the
world price of imports in the world market and a 40%
devaluation/depreciation in the Pakistani rupee from January 1991 to
June 1997 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 level of
imports is posting several implication for inflation. More than 60% of
our exports consist of cotton and cotton-based products which are
facing cut throat 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 the
developed countries.

tax to GDP ratio in Pakistan is only 13 to 14%, leaving the government
short of funds to run the machinery of the government. The
government has to resort to debt financing, money financing and
financing from external sources which put upward pressures of
different magnitudes on the price level.

The ratio of indirect to total tax revenues

in Pakistan is more than 70%. 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 non-banking 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% 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.

During an
Inflationary period it becomes very difficult for the government to fulfill
its commitments of achieving macro economics targets. Almost all
targets, such as GDP growth, price inflation, bank borrowing, trade
deficit and budget deficit are violated. This hurts the credibility of the
government. Costs of development project and non-development
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% inflation and an average 10% 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% in the country.
Redistribution of
income takes place during an inflationary regime. Resources are moving
from lender to borrower. As in the case of Pakistan, lenders are small
deposit holders and borrowers the rich elite. Double digit inflation is
aggravating the already high inequality between the rich and the poor.

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 situation.
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.

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.

Dollarisation; as defined by the ratio of foreign currency

deposits to total monetary assets (M2), takes place due to 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.

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).

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.



There has been a significant rise in inflation mainly caused by supply
shocks of essential food items and higher crude oil prices in the
international market. Some essential items like wheat and meat has
witnessed considerable increase during the outgoing fiscal year (2003-
2004) mainly spearheaded by supply shocks caused by
misadministration and hoarding (rather than actual supply shocks).
Even after the stabilization of food items supply, the inflation caused
4% ending with 4.6% surge in price level during 2003-2004. Some
prophets of doom and gloom gave an impression that price level is sky
rocketing, and the economy would crumble in near future. However,
that͛s not the case. Some analysts were also of the opinion that
inflation would accentuate macroeconomic imbalance and will hurt the
poor and the fixed income groups. Some went to the extent of linking
recent surge in inflation to imminent rise in the poverty level.

The recent surge in inflation is a global phenomenon and cannot be

viewed in isolation. Normally inflation is the by product of economic
growth and economist term it as greasing factor that is necessary for
economy to move at a brisk pace. There are always some sort of trade-
offs between employment and inflation. The inflation is an integral part
of economic activity and it is unavoidable. Higher growth is essentially
associated with higher inflation. The economic policy can only influence
one part of the inflation while other part is out of the purview of such a
policy. For example higher oil prices in the international market are out
of the purview of the economic policy making and food supplies are
driven by the performance of volatile agriculture sector. The
government can hardly influence the performance of the agriculture
sector. Core inflation is the true representative of the influence of the
economic policy on inflation.

As far as inflation is
concerned, Pakistan is comfortably placed in the camp of developing
countries since the last three years. It is a misconception that the
statistics released by the government do not fully translate the on
ground realities (although it is true that inflation in real terms is much
higher in the economy than reported by the government). Generally,
people take decrease in inflation rate as decrease in prices of most
items but in fact it might represent the declaration of the pace of
increase in price level.

It is common to
criticize statistics provided by the government without going into
proper analytical assessment. As a matter of fact the government
statistics are based on internationally recognized methodology of
collection and processing of information. These methods, in fact are
being practiced in both the developed and developing world in general.
In Pakistan, like most of world economies, the term inflation is
generally referred to the upward movement in Consumer Price Index
(CPI). The CPI index in Pakistan is based on a basket of 374 consumer
items selected on the basis of a Family Budget Survey conducted by
Federal Bureau of statistics in 2000-2001. Its objective is to measure
the change in cost of living due to changing prices of consumer items.
The consumer items are distributed in 10 groups of basket of goods and
services. The weight of an item represents the share of expenditure of
an average family on the specific item. The CPI is compiled by FBS
(Family Budget Survey) on the basis of monthly surveys. Its coverage
includes 35 major cities/urban centres across the country. While, all the
urban centres have been categorized into four groups by size of
population ranging from mega cities to urban areas with less than fifty
thousand population. The selection of these urban centres has been
made in such a way that ensures geographical and regional
representation of all the areas of the country. Each month, more than
100,000 prices are collected on the basis of a stratified random sample
covering four markets in these 35 cities. Price quotations are collected
for each of the 375 items from different shops in each market.

 cc ccÀ 

1950s 3.0
1960s 3.2
1970s 12.5
1980s 7.2
1990-97 11.4
1997-2002 7.8
2002-03 3.1
2003-04 4.6
The stereotype thinking about statistics provided by the government
has a historical background. Pakistanis are traditionally accustomed to
low inflation (see table-1). Only twice in the country͛s history of five
decades we touched double-digit inflation as far as average for decades
is concerned. The inflationary pressure persisted in the early 1990s due
to monetary overhang combined with shortage of essential
commodities continued until 1996-97 and the average for the first
seven years (1990-97) of the 1990s averaged at 11.4 % but continued
its declining trend thereafter. It declined to 7.8 % in 1997-98 and
further to 5.7 % in 1998-99. In 2002-03 it reached to 3.1 %, which is
lowest ever since 1969. Improved availability of agriculture and food
products has kept a firm check on the prices of milk, wheat, rice, beef,
mutton and poultry meat. The trend of declaration could not sustain
during the outgoing fiscal year and during 2003-04 CPI.

Moved up by 4.6 % against a target of 4.0% and actual achievement of

3.1 % last year. The main reason was the shortage of wheat in some
parts of the country.

important contributor to the inflation was higher oil prices in the
international market. The Oil Advisory Committee has already passed
on major portion of the oil price-hike to the consumers. The oil price-
hike is an international phenomenon beyond the control of the
The table-2 clearly implies that the inflation in Pakistan is modest as
compared to other developing countries. Pakistan͛s inflation rate of
4.6% during the outgoing fiscal year is far below that 1998-99 level. No
government in the world can be comfortable with soaring prices but in
modern growth centric economic policy making, inflation is
unprecedented and any forceful containment of inflation often caused
slowdown in growth and rise in unemployment. The government of
Pakistan is applying stringent and prudent policy measures to keep a
check on inflation.

  cc  À!"c

À"c    ##$#%
Bangladesh 5.1
India 5.0
Egypt 5.2
Mexico 4.3
Philippines 3.9
Iran 16.0
Turkey 12.0
Sri Lanka 6.0
Pakistan 4.6
India 5.0

The government must tolerate around 5% inflation to reach above 6.5%

growth during 2004-2005. The government should be vigilant about
food supplies and restrict State Bank Of Pakistan from doing any
unreasonable like upward adjustment of interest rates. This might
hamper the current growth momentum in the economy.

A persistent high level of monetary growth
should never be compromised to maintain stability in the external value
of currency and to control inflation effectively. The major factor
towards excessive monetary growth in the case of Pakistan is high
government borrowing as compared to the stipulated credit allocation
in the credit plan. This leaves less room for the private sector which is
considered more productive as compared to public sector. The Central
Bank should not act as the printing press for the government͛s finance
ministry. For example during 1996-97 the government of Pakistan has
taken more than Rs. 80 billion in credit as compared to revised target of
Rs. 61 billion from the total domestic credit expansion of Rs. 136 billion.
Unlimited injection of credit into the economy will aggravate the
already uncontrollable inflation in the country. Quick and transparent
privatization of government sector enterprises and use of privatization
proceeds towards debt retirement will ease the government͛s position
by reducing the amount of debt servicing. It will also lower the
government͛s budget deficit by the amount of losses incurred by these

Down-sizing the budget deficit by cutting

administrative expenditures and through increases in revenues by
broadening the tax base. The government should consult that group of
privileged people who is not contributing to government exchequer
currently so that it does not have to resort to increasing administered
prices to get extra revenue.
Inflation in Pakistan is hard to
control efficiently and quickly without 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 small farmers in
Pakistan to obtain credit. It is possible only after several visits to the
bank and after paying some percentage of the loan to mobile credit
officer (MCO) or to other officials. This increases the effective rate of
return and multiplies his miseries.

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 has a strong bearing on population growth and other
matters of social and economic well-being. Autonomy granted to State
Bank Of Pakistan is also a right step towards financial soundness and
the restoration of the value of currency. Performance of the State Bank
Of Pakistan 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.
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% is
also identified. On the basis of these 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