Project on Factors Affecting Inflation in Pakistan

By Muhammad Adil Abbasi

A project report submitted to the Department of Business Administration, Faculty of Management Sciences, International Islamic University, Islamabad in partial fulfillment of the requirement for the degree of

MASTER OF BUSINESS ADMINISTRATION (FINANCE)

Department of Accounting and Finance Faculty of Management Sciences International Islamic University Islamabad

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Project on Factors Affecting Inflation in Pakistan

By ADIL ABBASI (4229-MBA/FMS/S09)

MASTER OF BUSINESS ADMINISTRATION (FINANCE)

Submitted to

Sir Tahir Rizvi

Department of Accounting and Finance Faculty of Management Sciences International Islamic University Islamabad Feb 2012

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Copyright 2011 by Mr. Adil Abbasi All rights are reserved. No part of this project report can reproduce in any form or any means such as photocopy or electronic media etc. with out by approval of authors.

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Supervisors Certificate
This is certified that Mr. Adil Abbasi (4229-MBA/FMS/S09) of MBA-21 have completed their project report entitled Factors Affecting Inflation in Pakistan under my supervision. I have checked this report and found it bonafide work of authors.

__________________________ Sir Tahir Rizvi SUPERVISOR Assistant Professor

__________________________ Dr. Zaheer Abbas Head, Department of Accounting and Finance Faculty of Management Sciences International Islamic University Islamabad

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DEDICATION
This project is dedicated to our loving parents, teachers and friends. Without their knowledge, wisdom, and guidance, we would not have the goals we have to strive and be the best to reach our dreams!

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ACKNOWLEDGEMENT
We wish to acknowledge our fellows who helped us a lot in this project. The research for this project would not have been possible without the generosity of our Project instructor Sir. Tahir Rizvi. We also like to thank our teachers who always gave their precious advises to us for this project.

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CONTENTS:

CHAPTER 1
Executive Summary Objective of the study Methodology Statement of Problem 08 09 10 10

CHAPTER 2
Literature review 11

Types of inflation Effects of inflation.. Causes of inflation. Price indices in Pakistan CHAPTER 3 Historical data. Inflation trend in pakistan Inflation trend during 1990 to 1995 Inflation trend during 1996 to 2000 Inflation trend during 2001 to 2005 Inflation trend during 2006 to 2011 Impacts of inflation.. Measures of inflation CHAPTER 4 Our Substantial Exertion CONCLUSION BIBLIOGRAPHY

13 14 18 20

21 22 22 22 23 23 24 25

27 28 29

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CHAPTER 1

Factors Affecting Inflation in Pakistan

EXECUTIVE SUMMARY:

Inflation is an economic term or a monetary phenomenon which literally means increase in the prices of daily products i.e.(goods and services) over a period of time. It also means a decline in the value of currency or the depreciation of the currency. It occurs when there is excessive supply of money in the economy and low demand of it. Its the monetary policy of a certain country that ensures the price stability or the primary goal of a countrys monetary policy is the stability of prices of daily goods and services. In Pakistani context inflation has a great impact on economy of Pakistan. Since last 15 years our economy is in an inflationary spiral of wage and price increases. Inflation is the key indicator of countrys economic conditions and it gives the insight on macroeconomic policies of a country that govern it. State bank of Pakistan expect that the inflation rate during fiscal year 2011-12 would be about 14.5% to 15%. The major causes of inflation in Pakistan are macroeconomic instability, more imports than exports, natural calamity, political instability and higher duties and taxes. There are some other factors or aspects that contributes towards more inflation like shortage of electricity, internationally increase in the prices of oil and gas, more custom duties on imports etc. Inflation is always b a big problem for Pakistan and there must b a complete, reliable, honest and fair strategic planning to control the increasing trend of inflation in Pakistan.

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OBJECTIVE OF THE STUDY:

Our main objective or purpose of studying inflation is to understand the real meaning of inflation and its impact on the economy. It is not an easy task for us to completely demonstrate the reasons of inflation and its impact on the whole society but we have made an effort to at least come across the most prominent reasons or major factors that contributes more to enhance inflation in a society or economy like Pakistan. Our main focus is Pakistani economy and how inflation occurs in our economy and what are the major factors that contributes towards more inflation or increase in inflation in a given circumstances. In Pakistani economy we have observed that our economic condition were always in a condition of uncertainty because of political instability in general and also because of the failure of our monetary policy. We have also observed that in Pakistan inflation trend is increasing that is harmful not only for the society but also for the macroeconomic stability. As our majority of population is living in a hand to mouth condition so continuous increase in the inflation would be very destructive.

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METHODOLOGY:
We have used different methods or different tools for the collection of data. Though the data collection process is not that much easy task for us but we have made our possible efforts to gather all the relevant information about our project i.e. Inflation. We have collected the secondary data because of the limitation of the project but our main focus will be on primary information or primary data. We have visited the official websites of National Bank of Pakistan (NBP), economic survey of Pakistan and other relevant areas to collect all the possible information regarding inflation. We have illustrated the impact of inflation on our economy and major factors that contribute towards increasing inflation in economy like Pakistan.

STATEMENT OF PROBLEM:
As inflation is always considered as a hurdle for any economy in the way of success and economic growth. Pakistan as an agriculture based country also had a negative impact of inflation on its economy. Increasing price of daily products such as food items, gas, oil and electricity utterly cleaned out prosperity of life. We suffered increasing trend of inflation in Pakistan which must need to be controlled by taking some brave initiative like exporting more than importing, improve standard of our exports, quality of our exports etc. State Bank of Pakistan (SBP) must needs to play a significant role by issuance of new currency as per requirement of the country and try to control the continuous depreciation of currency against other currencies like US $. Our work is totally based on determining the key factors that significantly contribute towards the more inflation in a country, and what are the sound effects of high inflation upon our economy and whole society.

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CHAPTER 2

LITERATURE REVIEW:
Mostly scholars believe that inflation is a situation where demand of goods and services exceeds supply that leads towards a sustainable increase in prices of goods and services. According to Friedman and other economist; Inflation is a monetary phenomenon; Inflation began because monetary policy makers felt constraint to accommodate expansionary fiscal decision and actions article by Meltzer

Federal Reserve Chairman William McChesney Martin said in 1958: If inflation should begin to develop again, it might be that the number of unemployed would be temporarily reducedbut there would be a larger amount of unemployment for a long time to come (Federal Open Market Committee [FOMC],)

Edward Nelson (2004a, b, and Nelson and Nikolov, 2004) According to them inflation is the negligence of policy makers or monetary policy. Meltzer believes that some of the inflation around the world is just because of American inflation exported to other countries with the help of bretton woods system. According to an article on inflation:

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Inflation is easy to stop as a theoretical matter; this is why it is so difficult to stop as a practical matter. Inflation never "runs away." Only by stupidly persisting in expanding the money supply do governments overcome the deflationary impact of price increases and impose chronic inflation on an economy.
RONALD REAGAN once described inflation as being as violent as a mugger, as frightening as

an armed robber and as deadly as a hit-man. According to Crowther, inflation is a "state in which the value of money is falling, i.e., the prices are rising."
Harry G. Johnson states, "I define inflation as substantial rise in prices.

In the words of Gardner Ackley, "Inflation is a persistent and appreciable rise in the general level or average of prices." According to Websters New Universal Unabridged Dictionary published in 1983 the second definition of inflation after the act of inflating or the condition of being inflated is: An increase in the amount of currency in circulation, resulting in a relatively sharp and sudden fall in its value and rise in prices: it may be caused by an increase in the volume of paper money issued or of gold mined, or a relative increase in expenditures as when the supply of goods fails to meet the demand.

According to investorwords.com The overall general upward price movement of goods and services in an economy, usually as measured by the Consumer Price Index and the Producer Price Index; opposite of deflation.

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Types of inflation:
Inflation means a rise in the prices of goods and services. Inflation could be creeping, walking, trotting, running; hyper inflation, demand pull and cost push inflation etc. It always caused by some demand and supply side factors. If it is because of more demand than it create a demand pull inflation and if it is because of increasing cost than it create a cost push inflation. When more consumers have strong desire for a single product than producer of that product charge more for that product because of increasing demand of the product Following are the important types of inflation i.e. Demand pull inflation Cost push inflation Stagflation Hyper inflation etc..

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Effects of inflation:
Following are the most important effects of inflation in Pakistan: Economic instability Less exports and more imports Natural calamity Political instability Higher duties and taxes Print an excess of money More production cost International lending and national debts Devaluation of currency

Now I would like to interpret the above mentioned effects or factors of inflation in detail.

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Economic instability: Economic stability is not only important for the overall growth of the economy but it is also important for the survival of economy or country. In Pakistani perspective, I must say that our economy is not stable because of lack of proper administration by our government. Economic stability is when there is a balance in the demand of the consumer of goods with the supply of goods by the supplier. Our natural resources were always been underused by our government or ignored by our government rather than that our government is focusing on more and more atomic resources and maintain profound budget for nuclear missile and nuclear technology, which again put more pressure on economic growth of the country. Our national saving is also continuously declining because of weak macroeconomic policy. During Musharraf government tenure our macroeconomic stability was strong and recovering with great pass but after that because of more changes in policies by our think tank our economic stability collapse. Pakistan must need to give the investor a place where they go for invest without any fear of bankruptcy and insolvency. They must need to offer the promise of economic stability in the country, a legal system that protect investor ,well trained and skilled labor force and large rate of domestic savings. Less export and more imports: If our local products have no access to the international markets than how could we say that our exports will increase over the time. Controlling inflation must need to be a primary concern for our government. Our products or exported products must need to fulfill the international standards of quality so that foreign consumer demanded more for our products. Government should need to implement a strong or strict policy regarding imports in and exports out from the country. With the absence of basic structure of industries in Pakistan imports become critical and rising by the time. Pakistan all the time during last few years faces the trade deficit because of more consumption on imports rather than on exports or savings which

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is not good for the macroeconomic stability, there must be a equal balance between our imports and exports. Natural calamity: Nature is totally an independent factor or an external factor which out of control by the human being, its beyond our capacity to control natural calamity like floods and earthquake. Our economy suffer a lot because of a big disaster in October 2005 i.e. highly destructive earthquake in Pakistan which totally destroy our economy by destruction of our infrastructure, roads, telecommunication system etc. Though after that hard period our economy is still regaining the pass towards the economic globalization and economic growth but again it needs more concentration for more acceleration in the growth of our economy. Natural calamities, invasions and diseases affect the agriculture sector which further leads towards more increase in the prices of goods and services that enhance the inflation in the economy. Higher duties and taxes: Government must need to ensure the reliable and complete taxation system in the country. Government needs to charge reasonable tax on the domestic goods which is under the control of every consumer. It must need to reduce the duty charges or tariff on the exported goods so that our export to other country increases. Government needs to established better investment policies with in the country with attractive markup or interest rates that will not only attract the local investor but also the foreign investor would prefer to invest in our country. Poverty: Poverty is also one of the big elements of more inflation in our country. Though Pakistan is generating $140 billion but it is not sufficient for our economic wealth and survival. Our wealth distribution policies should be faire so that it benefited the whole society and only to those who have more influence. The ratio of the income of richest and poor people went up from3.76 to 4.15 by year 2008 but it needs more

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acceleration for more economic prosperity and for more reduction in overall inflation in the country.

International lending and national debts: Our international borrowing ratio also increases very sharply. Pakistan has borrowed around $3 billion during 2007 and it is now double than the previous. That much international borrowings means to pay huge debt and more current account deficit. With that much external borrowings and debt payments our government will not be successful to provide the basic needs of the country. This forces our government to import more and more that will affect our exports to other countries. This story shows the lack of vision, lack of proper planning and lack of long term strategy More production cost: More production cost invites cost push inflation in the country which needs to control. Rising labor cost, rising raw material cost and higher taxes and duties imposed by the government enhances the overall production cost. Government must need to provide or must need to ensure the availability of raw material at a cheapest cost that will reduce the production cost.

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Causes of inflation:
As inflation is a steady increase in the prices of goods and services. More inflation in an economy put massive pressure on real income or on the GDP of the country. Inflation has both positive and negative impacts on the economical condition of certain country. As it also known as
a decline in real value of money or currency which ultimate outcome is decrease in the purchasing power of money and its depreciation. Those people who get income as fixed salary suffer more as their spending power decrease contrary to that those who didnt have fixed income can handle it effectively by simply increasing their income. It helps those who have surplus of money that they can charge more to take the advantage of higher price level. Employment level also decreases because of high inflation in the economy. Because of high inflation chances of direct foreign becomes low, foreign investor would never like to invest because if he will go for that investment he will never get the desired profit margin from his investment because of continuous depreciation of currency. High inflation in any country around the world reflects the failure of monetary policy which conveys the bad impression to other invertors who want to invest in that particular country. Inflation weakens the function of money as its face value goes down by continuous depreciation. Inflation also has some negative effects that during inflation people normally try to hold the food items that create the shortage of foods in the market which again puts more downward pressure on economy. Savings also b affected by high inflation as the value of money tends to decrease day by day which more consumption rather than saving. Profit margin of the companies will also b affected by high inflation if they dont consider the inflation rate while calculating the profit. People will also have to pay more tax if there is a high inflation prevailing in the economy. Investment ratio or investment trend also going down sharply because of more inflation and people would never go for investment. Inflation helps those who are actually the responsible for creating inflation in the economy like industrialist people, or the people who have surplus of food items stored. It helps the borrower as he has to pay less money back to the lender of the money. Banks or other institutions that lending money are normally aware of this situation so they normally charge more

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interest during high inflation period. Economist prefer low and steady inflation rate as it is good for reducing chances of economic recession. Now I would like to mention some main causes of inflation

Demand Pull Inflation:

Demand pull inflation occurs when aggregate demand for goods and services increase while supply side remains unchanged which ultimately increases the prices of the goods and services. When there is more demand in the market or economy then the producer of goods and services tends to increase the prices of certain goods and services to get the marginal profit because of difference between demand and supply. Following are the major causes of demand pull inflation.. Depreciation of the exchange rate Higher demand by government Faster economic growth Improved business structure Monetary stimulus to the economy

Cost Push Inflation: Cost push inflation occurs when businesses increase the prices of goods and services because of increase in the production cost to maintain their profit margin. Cost may increase because of increase in the raw material cost, labour cost and also because of higher indirect taxes imposed by the government. Whenever there is increase in the wages of labor that means certainly increase in the production cost of material also. Following are the main reasons of cost push inflation in an economy.. Component costs Raising labour costs

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 Higher indirect taxes imposed by the government Fall in the exchange rate

Price indices in Pakistan:

There are four different price indices that are being used in Pakistan i.e. a. Consumer Price Index (CPI) b. Wholesale Price Index (WPI) c. Sensitive Price Index (SPI) d. GDP deflator CPI is the main measurement of inflation at retail level and it covers the prices of 374 items in 35 major cities of the country that reflects the changes in prices during the particular period. WPI shows the price changes of most consumable goods at both primary and secondary level. Data for WPI is normally collected from wholesale market by visiting to mills, factories, industries and also by conducting survey of the complete wholesale market. It covers the prices of 106 commodities or items from 18 major cities of the Pakistan. SPI reflect the weekly change in the prices of 53 items that are being used by household at daily basis. SPI cover the 17 major cities of the country and it covers all the income level group of people. But in Pakistan CPI measure is mostly used as it cover the prices of 374 items from 71 markets of 35 cities around the country.

Most commonly used Price Indices of Pakistan:

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Name Cities covered Markets covered Items covered Commodities covered No. of groups

CPI 35 71 374 92

SPI 17 53 53 _

WPI 18 18 425 106 5

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CHAPTER 3 Following is the historical data regarding inflation at SPI, CPI and WPI from 1991 to2007.

Period 1991-1992 1992-1993 1993-1994 1994-1995

SPI
10.54 10.71 11.79 15.01

CPI
10.58 9.83 11.27 13.02

WPI
9.84 7.36 11.40 16.00

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1995-1996 1996-1997 1997-1998 1998-1999 1999-2000 2000-2001 2001-2002 2002-2003 2003-2004 2004-2005 2005-2006 2006-2007

10.71 12.45 7.35 6.44 1.83 4.84 3.37 3.58 6.83 11.55 7.02 10.82

10.79 11.80 7.81 5.74 3.58 4.41 3.54 3.10 4.57 9.28 7.92 7.77

11.10 13.01 6.58 6.35 1.77 6.21 2.08 5.57 7.91 6.75 10.10 6.94

Inflation trend in Pakistan:

Inflation is always considered as hindrance in the way of success for any country or economy. Inflation has a great historical relation with Pakistani economy; majority of our population is being affected by inflation over the period. There must b a complete strategic planning to overcome its impacts on society or economy like Pakistan. Pakistani economy is very much affected by high inflation during last two decades. Inflation trend during 1990 to 1995: The average SPI measure inflation rate during that period was 11.6% which is a double digit inflation that is a damaging sign for any growing economy. CPI average during that

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period was 10.85% and WPI average was 10.92%, main reasons for high inflation during that particular period was the failure of monetary policy and also the printing of more money but the value of currency during that period becomes low that put more pressure for creating inflation in the economy. During that particular period world wide inflation was also bit higher than usual that was also the factor of more inflation in Pakistani economy during that period. Inflation trend during 1996 to 2000: Inflation at SPI measure during that period was 7.75% on average that is 3.8% lees than previous average rate of inflation. Inflation rate on average by CPI measure during that period was 7.9% that is also about 2.9% less than previous CPI rate of inflation. Inflation rate on average by WPI measure during that period was 7.76% that is also less than previous WPI rate. During that period world wide inflation was also not that much higher that put downward pressure on inflation in Pakistani economy. Imports were almost same as the exports that give strength to the currency of our country that reduce the inflation ratio during that period. Agriculture sector of the country during that period yield more than usual that also helps a lot to reduce the inflation level. State bank of Pakistan made the strict monetary policy during that period that also gives strength to local currency which reduces the level of inflation.

Inflation trend during 2001 to 2005: Average inflation during that period at SPI measure was 6.0% which comparatively lower than previous record that indicates the overall growth of the industry during that period. Inflation at CPI measure during that particular period on average was 4.9% which again shows implementation of better monetary policy or better performance of State bank of Pakistan during that particular period. Inflation at WPI measure during that period on average was 5.7% which also comparatively lower than the previous. The overall growth of economy during that period was also not that much impressive but some how better than the last five years results.. Inflation trend during 2006 to 2011:

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The average inflation rate during during that fiscal period till now is about 12% which is again a double digit inflation and very harmful for the economic growth of the country. Though our monetary institutions are working very hard to control the inflation but there are some external factors that contribute towards creating more inflation in Pakistan. Pakistani imports are increasing day by day because of more demand and less supply of exports inside the country. Our exports to other country decreasing day by day because of low quality standard and cheap material. Fight against terrorism is now a primary focus for our politician rather than economic growth of the country. Drone attacks by USA in our territory totally damage our infrastructure apart from human being loss, which also contributing towards more frustration among our youth our overall society, lack of production, lack of foods and shelter and so on, all these factors are the sources of more or increasing inflation rate in Pakistan during that period.

Impacts of inflation on economy:

As inflation is a monetary term so it has both the positive and negative impacts on the economy of a country. Inflation affects all the major sectors of the economy like social sector, economical sector and technological sector environment also. Inflation is also a threat for standard of living that means you have to pay more for the same goods and services because of the rapid increase in the prices that is harmful for a common people of the society. If the increase in the inflation is equal to the increase of the income of a household than it would not be problem anymore but on the other scenario if there is a gap

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between increase in income and increase in inflation than it will surely disturb the whole life of a common people even if his earning is increasing. Inflation leads to a rise in the general price level so that money loses its value. When inflation is high, people may lose confidence in money as the real value of savings is severely reduced. Savers will lose out if nominal interest rates are lower than inflation leading to negative real interest rates. For example a saver might receive a 3% nominal rate of interest on his/her deposit account, but if the annual rate of inflation is 5%, then the real rate of interest on savings is -2%. More generally, inflation can disrupt business planning. Budgeting becomes difficult because of the uncertainty created by rising inflation of both prices and costs - and this may reduce planned capital investment spending. Lower investment then has a detrimental effect on the economys long run growth potential.

Meausures & policies to control inflation:

Inflation could be controlled by using following two measures, Monetary measures Fiscal measures Monetary measures: One of the main important method of controlling inflation is the monetary policy of the central bank. Banks normally charge high interest rate in that regard to prevent inflation.

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Monetary measures include: Bank rate policy Cash reserve ratio and Open market operations. Control over money Credit control The idea of bank rate polisy is that the central bank raises the bank rate which increases the cost of borrowing that reduce the borrowing of commercial banks from the central bank and from commercial banks to genral public consequently. To control inflation, the central bank raises the CRR which reduces the lending capacity of the commercial banks. Consequently, flow of money from commercial banks to public decreases. Open market operations refer to sale and purchase of government securities and bonds by the central bank. To control inflation, central bank sells the government securities to the public through the banks.

Fiscal measures: Fiscal measures to control inflation include taxation, government expenditure and public borrowings. The government can also take some protectionist measures (such as banning the export of essential items such as pulses, cereals and oils to support the domestic consumption, encourage imports by lowering duties on import items etc.). Here the following fiscal measures that governament could take, Decrease in public expendituures:

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Delay in payment of debts: Increase in taxes: Over valuation of money:

There are some other measures which includes, Increase in production Proper commercial policy Savings Proper investment policy

CHAPTER 4

Our Substantial Exertion: Our main purpose of this project was learning of how inflation could effects the economy of any country all over the world, but without the assistance of our calm and cool instructor and supervisor Sir Tahir Rizvi it would b a simply impossible task for us. They have support us during all the time for the better understanding of project and inflation and

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also how should we need to accomplish our project. They also give us better insight of inflation its history and its about its effects to an economy. As inflation is a monetary term or phenomenon so have got lots of information about inflation through text books, yearly economic survey of Pakistan, official web sites of State bank of Pakistan, articles, journals and newspapers etc. We have downloaded the previous 20 year data of Pakistani economic conditions, economic health Pakistani markets and industries and the inflation history. We have go through the yearly data or rate of the inflation, we have understand the meaning of inflation in real term. After a deep analysis of data we have understand the different types of inflation and its impacts on economy.

CONCLUSION:

Inflation is a monetary phenomenon and it is very hard to better understand the real meaning of inflation in real world or in practical perspective. Pakistan is agriculture based country and it has a huge labor force around 50% of the total population. Inflation always played a significant role in the economy of Pakistan. I want to show my real feelings that our government is totally fail to control inflation in Pakistan. I request to the prime minister of Pakistan and to the president of the Pakistan to please wakeup from the deep sleep and for god sake think for the poor nation or poor people of the Pakistan and middle class

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people of the Pakistan. They must need to monitor all the aspects of the economy very carefully with sincerity and loyalty. Fair price standard should need to b implemented for all the people of the country and government must need to play its fundamental role for the assurance of implementing fair pricing policy standards. Check and balance system should need to b improved that will reduces the chances of corruption in the society. Pakistan needs to enhance its industrial sector by supporting them like offering short term loans to our farmers. Give them assistance for increasing the productivity and yield. State bank of Pakistan recently announce that the projected inflation rate during that fiscal period would be around 14% to 15% which is not good for the economic growth of the country. We must need to improve quality of our exports and need to maintain the higher standard of our exported goods and services that will result in decrease in the inflation rate in coming years.

BIBLIOGRAPHY

http://www.google.com

http://www.wikipedia.com
Official website of SECP

Federal Bureau of Statistics

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 Economic Survey of Pakistan 2005-2006

Economic Theory (K.K. Dewett, P. A. Samuelson, Parkin)

Journals of the Chief Economist of WB

Official website of state bank of pakistan.

Search engine Different books of economist. Finance.gov.com.pk

HistoryLearningSite.co.uk

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