IN THE NAME OF ALLAH, THE MOST BENEFICIENT,

THE MOST MERCIFUL

MUHAMMAD ABDULLAH
DR. RUKHSANA KALIM

DETERMINANTS OF FOOD PRICE INFLATION IN
PAKISTAN: AN EMPIRICAL ANALYSIS

INTRODUCTION
In the recent years, food price inflation has risen very
sharply at global level. According to Commodity
Research 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 capita
income, urbanization and change in dietary habits
are the main reasons of sharp increase in demand
and prices of some basic food items.

INTRODUCTION

Because of higher food inflation households have to
make reductions in some areas of food consumption
leading to malnutrition.

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

High inflation erodes the benefits of growth and
leaves the poor worse off.
(Esterly and Ficsher, 2001)

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 and
2008-09 respectively. Moreover, food inflation
remained more than 10 percent on average from
1972 to 2009, in the whole history of (West)
Pakistan.

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
LITERATURE REVIEW
Two Schools of Thoughts (sources of inflation)
1. Monetarist
Friedman (1968, 1970 and 1971), Schwartz (1973)
Demand-side factors (money supply, real money
balances)

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 )
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 showed
positive relation with food price inflation and
agriculture output was negatively cointegrated
with food price inflation.


Khan and Schimimelpfenning (2006)
Found that broad money growth and private sector
credit growth were the key variables of inflation in
Pakistan. Support prices influenced inflation only in
short 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 and
expectations were positive and highly significant on
food price inflation. Money supply showed an
insignificant impact on agriculture food prices

Lorie and Khan (2006)
Concluded that there is only a weak evidence of the
existence of long run co integration between domestic
prices, international prices and support prices for key
agricultural goods in Pakistan.

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


MODEL SPECIFICATION

Economic literature on inflation provides some
inflation 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), the
stylized 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.
The above quation can be rewritten for estimation purposes as follows:




t= 1, 2, 3, ., 37.
(time period ranging from 1972-2008)
FPI
t
= Food Price Inflation (CPI food as proxy of Food Price Inflation)
in time t
FPI
t-1
= one year lag of FPI
t
(as proxy of inflation expectations)

M2GR
t
= Growth Rate of Money Supply (M2) in time t
PGDP
t
= Per Capita GDP(in Pak rupees) in time t
ASP
t
= Agriculture Support Price (rupees/40kg of wheat) in time t
FX
t
= Food Export (as percentage of merchandise export) in time t
FM
t
= 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
= o + o + o + o + o
+o + o + c
t t-1 t t t t t
FPI f (FPI , M2G , PGDP , ASP , FX , FM ) =
ECONOMETRIC METHODOLOGY
Stationarity and Non-stationarity
A stationary series is time invariant and fulfills the
properties of constancy doctrine i.e. constant mean
and constant variance and co-variance. In contrast,
a non-stationary series violates one or more
properties of constancy doctrine.

Augmented Dickey-Fuller test was proposed by
Dickey and Fuller (1979, 1981). It is widely used in
economic literature to investigate the stationarity of
a time series data. Dickey and Fuller (1979, 1981)
have tabulated critical values for t

which are called

(tau) statistics. Dickey and Fuller unit root test
can be applied under following two steps.


The Augmented Dickey-Fuller (ADF) Test

Step 1, OLS is regressed on the following equation
and save the usual t

values.



Step 2

The existence of unit root is decided on the basis
of following hypothesis;
H
0
: for non-stationary if t

H
a
: for stationarity if t

<
1 1
1
q
t t j t j t
j
X t X X o | o

=
A = + + + A +e

Johansen Co-integration Test

Engle and Granger (1987) method finds out only one
co-integrating vector through two step estimation
approach.

While on the other hand, number of vectors can be
found using maximum likelihood testing procedure
suggested by Johansen (1988) and Johansen and
Juselius (1990) in the Vector Autoregressive (VAR)
representation.
DATA SOURCES
Annual data from 1972 to 2008
Variables Sources
CPI food (FPI) Various issues of
Pakistan Economic
Survey
Agricultural 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)
Augmented Dickey-Fuller (ADF) Test at 1st Difference
Variables Trend & Intercept Prob. Values
FPI
t
-4.0928* 0.0156
M2G
t
-7.8567** 0.0000
PGDP
t
-3.4095* 0.0173
ASP
t
-3.7743* 0.0302
FX
t
-8.2416** 0.0000
FM
t
-6.0840** 0.0000
Note: * represents significant level at 1%.
** represent significant level at 5%.
VAR Lag Order Selection Criteria
Lag AIC SC HQ
0
53.61601 53.88264 53.70805
1
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 criterion
HQ: Hannan-Quinn information criterion
CO-INTEGARTION AMONG THE VARIABLES
Same order of integration one I(1)
Johansen co-integration
Maximum Eigen Statistics
Trace Statistics
Unrestricted Co-integration Rank Test (Trace)
H
0
H
1
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)
H
0
H
1
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
Long Run Relationships
Dependent Variable = FPI
t

Variable Coefficient T-Statistic Prob-Value
Constant -44.90991 -4.941833 0.0000
FPI
t-1
0.735522 15.78609 0.0000
M2G
t
0.073152 1.499076 0.1447
PGDP
t
0.001740 5.343473 0.0000
ASP
t
0.055197 4.131034 0.0003
FX
t
0.479935 3.675908 0.0010
FM
t
0.272316 2.384839 0.0238
R
2
= 0.9986
Adj-R
2
= 0.9984
F-Statistic= 3656.589
Prob(F-statistic)= 0.0000
Durbin-Watson
= 2.1329
Short Run Relationships
Dependent Variable = FPI
t
Variable Coefficient T-Statistic Prob-Value
Constant -0.163500 -0.219200 0.8284
FPI
t-1
0.800563 3.808210 0.0009
M2G
t
0.059029 1.530154 0.1396
PGDP
t
0.001114 1.477726 0.1530
PGDP
t-1
0.000463 0.536597 0.5967
ASP
t
0.058287 4.446252 0.0002
ASP
t-1
-0.006688 -0.219333 0.8283
FX
t
0.354770 2.831904 0.0094
FX
t-1
0.134124 1.919740 0.0674
FM
t
0.275443 1.794954 0.0858
FM
t-1
0.009114 0.071144 0.9439
ECT
t-1
-0.991143 -3.614136 0.0015
R
2
= 0.915113
Adj-R
2
= 0.874
F-Statistic= 22.54085
Prob(F-statistic)= 0.0000
Durbin-Watson
= 2.092
Diagnostic Tests
Normality Test(Jarque-
Bera Statistics)
Jarque-Bera Statistics
= 1.5011
Probability = 0.4721
Serial Correlation
(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
Heteroskedasticity Test
(White Heteroskedasticity
Test)
F-statistics = 1.4383 Probability = 0.3075
Model Specification Test
(Ramsey RESET Test)
F-statistics = 1.4383 Probability = 0.3744
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.
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.
CONCLUSION

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



First of all, stationarity of time series was checked by
using 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.


CONCLUSION


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

Long run coefficients showed that the impact of all
independent variables on food price inflation was
positive and statistically significant except money
supply growth. All the coefficients had expected
positive signs.

CONCLUSION

On the basis of empirical results we may
conclude that food price inflation is not a
monetary phenomenon in Pakistan. While the
supply side factors or structural factors have
dominant 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 of
ECTt-1, which is (-0.9), indicated the very high
speed of convergence towards equilibrium.

POLICY IMPLECATIONS
Inflation expectations
Continuity and consistency in governments economic
policies

Strong policy statements and actions will help to dampen
inflationary expectations

Support prices
Government should pursue a moderate policy in raising
support prices to slow down the inflationary pressures and
maintain the reasonable production level of food grains

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

Government should also encourage and support farmers to
adopt modern technology for higher production with lower
production cost.






Economic growth

Proper policy for agriculture sector to fill the output gap

Credit facilities should be provided through formal and
informal channel.

Improve infrastructure, agriculture markets and land
ownership system

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

Growth in Money Supply

Government should encourage the expansion in private
sector credit, especially towards the agricultural and its
related sectors

There should be the availability and easy access of loans
for all farmers for all types of their needs such as
expenditure 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 for
optimal utilization of the potential of agriculture sector

Imports of food

We need to exploit our unrealized yield potential in production
of food items as God has gifted us with all necessary
resources.

Sound agriculture development strategies and result oriented
agricultural policies should be adopted by the government to
produce foods in the country.



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