Does Inflation Matter for Sectoral Growth in Pakistan? An Empirical Analysis

• Author: IMRAN SHARIF CHAUDHRY, MUHAMMAD AYYOUB and FATIMA IMRAN

Abstract. The present study makes vigorous attempt to analyze empirically the impact of inflation on sectoral growth of Pakistan. Three major sectors (i.e. agriculture, manufacturing and services) have been selected for analysis and study employed annual time series data started from year 1972 to 2010. It is found that impact of inflation on sectoral output differs substantially according to the nature of the sector. Prevailing inflation is harmful to the manufacturing sector growth; whereas, the effect of inflation on services sector growth is in sharp contrast with the manufacturing sector growth results. The statistically significant positive impact of inflation was found to encourage the services sector growth. It is observed that inflation and agriculture sector growth is positively and significantly related. It is suggested to restrict the inflation in a single-digit zone; so that it may put forth its positive impact on sectoral growth.

Moreover, it is also concluded that the very low level of inflation in the economy may not be beneficial to the growth of agriculture and services sectors in Pakistan.

Keywords: Agriculture sector, Inflation, Manufacturing sector, Pakistan, Sectoral growth, Services sector

JEL classification: E31, E58

I. INTRODUCTION

The issue of inflation has been remained on the top among other economic problems in Pakistan in the recent years. It is argued that less productivity in agriculture sector and ”so called“ shortage of goods and services used in the production of agriculture sector are considered liable for causing inflation. Rise in prices in economy are resulted from supply shocks of specific food items and to oil market in the world. In adding together, intermittent oil prices are the compact mirror image of rigid wages as well as price structure is a new source to mount in general price level of roughly all other goods and services in Pakistan (Ayyoub et al., 2011).

Current account deficit and government fiscal policy have string inter- linkage. Fiscal policy pushes up domestic demand for goods and services that increases load on the current account deficit. From a different angle, it causes to enlarge the gap between investment and saving. If this gap is backed up from creation of money in spite of financing from external sources, inflation will be amplified (Khan et al., 2007).

Increase in general price level is also a consequence of government borrowing from State Bank of Pakistan (SBP) to finance its expenditures. The expansionary monetary policy is supposed to give addition in high inflation rate in the economy. Increase in the demand of the imports also contributing towards inflation to rise. In this situation, exchange rate depreciation in the economy of Pakistan is also exerting pressure on inflation upward. A small number of economists hold the view that indirect taxes are responsible for inflation in Pakistan (Khan et al., 2007). Wheat price sustaining polices are also a vital determinant of increasing inflationary pressure in Pakistan (Hasan et al., 1995; Khan and Qasim, 1996).

Low income group in Pakistan is going to spoil because more than half of total budget is utilized in purchasing of food stuff. High inflationary situation also creates disparity in the distribution of income disturbing fixed income group more as compare to owners of assets and earners of large and variable income (Hasan et al., 1995; Khan and Qasim, 1996). Long-run effect of inflation is a pure source of expansionary monetary policy and other structural problems influence the prices to boost up (Khan and Schimmelpfennig, 2006).

Above debate signify that inflation and sectoral output of Pakistan are inter-dependant with one another. Inflation could increase the sectoral output to some extent at the cost of hurting all sectoral growth of Pakistan economy.

The question of interest is to analyze the impact of inflation on different sectors of the economy. Does it encourage or hurt the sectoral growth in a uniform way or it behaves differently among major regions of the economy, depending upon the state and structure of the sector? Technically speaking, this study is based to explore the answer of the question; whether inflation in Pakistan is encouraging the growth of manufacturing, agriculture and services sectors or something else is happening due to inflation in Pakistan? The specific objectives of the study are:

1. To evaluate the growth performance of different sectors of the economy of Pakistan and to analyze the magnitude of impact of inflation on different sectors and the difference in this magnitude according to the nature of each sector.

2. To establish and inspect the realistic benchmark level of inflation for growth of different sector of Pakistan economy. To give the policy suggestions, after taking care of estimated results about their statistical significance to find out relationship between inflation and output of different sectors of the economy.

The rest of the paper has been arranged as follows; section II analyzes the structure and trends of inflation and sectoral growth in Pakistan. Section III consists of the theoretical framework, whereas a brief review of very limited existing literature on the topic has been presented in section IV. Data, methodology and model specification have been explained in section V. The empirical estimations of the models of sectoral growth are brought into analysis in the section VI. Conclusions and policy recommendations are provided in the last section.

II. STRUCTURE AND TRENDS OF INFLATION AND SECTORAL GROWTH IN PAKISTAN

The historical trend analysis indicates that inflation in Pakistan has explicitly negative impact on the growth of GDP and manufacturing sector growth. Whereas, it is found positively correlated with the growth of services sector, but it remains inconclusive in the case of agriculture sector. The growth rates and shares of these sectors in the GDP in various years have been presented in Table 1, which has been explained in respective sub-sections of the selected sectors.

Manufacturing Sector Growth and Inflation

Manufacturing sector, comprises of small scale and large-scale manufacturing sub-sectors, is considered as an engine of the economy. The share of this sector in GDP, though gradually growing, has not remained up to the expectations of the policy makers. After 1972, it had to face different type of policies resulting in various different outcomes. This sector faced the nationalization policy of industries and, after that, experiencing the privatization policy of successive governments.

TABLE 1 Sectoral Growth Rates and Shares in GDP of Pakistan in Various Years

Agricul- Agricul- Manufa- Manufa-

GDP ture ture cturing cturing Services Services

Years Growth Growth Share in

growth share in Growth Share in Rate GDP

Rate rate GDP Rate GDP

1950s 3.3 1.7 50.0 8.2 9.7 5.5 30.1

1960s 6.7 5.1 41.2 9.9 14.1 6.0 35.5

1970s 4.8 2.4 35.7 5.5 15.2 6.3 39.6

1980s 6.4 5.4 27.2 8.2 19.0 6.7 44.9

1990s 4.5 4.4 25.0 4.8 18.0 4.6 49.2

1999-00 3.9 6.1 26.2 1.5 14.8 4.2 51.2

2000-01 1.8 Â2.2 24.4 9.3 15.7 3.1 52.5

2001-02 3.1 0.1 23.6 4.5 15.7 4.8 53.4

2002-03 4.8 4.1 23.6 6.9 16.2 5.2 53.4

2003-04 6.4 2.2 22.3 14.1 17.6 6.0 52.7

2004-05 8.4 7.5 21.6 12.5 18.2 7.9 53.3

2005-06 5.8 6.3 22.5 8.7 18.8 6.5 51.7

2006-07 6.8 4.1 21.9 8.3 19.0 7.0 51.8

2007-08 3.7 1.0 21.3 4.8 19.2 6.0 52.9

2008-09 1.2 4.0 21.9 Â3.7 18.3 1.6 53.1

2009-10 4.1 2.0 21.0 5.2 18.5 4.6 53.5

Source: Pakistan Economic Survey (Various issues), Ministry of Finance, Islamabad.

Table 1 shows that the manufacturing sector’s share in GDP remained around average of 17 percent during the study period, while it remained highest during FY 2006-07. Figure 1 shows the trends of manufacturing sector growth and CPI inflation in Pakistan. Negative growth rate of this sector was observed during the FYs 1994-95, 1996-97 and 2008-09, while it crossed double digit figure during six fiscal years in the study period. The CPI inflationary trend shows that whenever inflation in the country entered into the double-digit zone, the manufacturing sector growth rate tended to decrease. The two presented trends demonstrate negative association between inflation and this sector’s growth.

FIGURE 1 Manufacturing Sector Growth and CPI Inflation in Pakistan

Moreover, Figure 1 indicates that double-digit inflation seriously hurts the growth of this...