Money, Banking and Finance

Division

Pakistan Institute of Development Economics

1
• Pakistan is facing unprecedented high Inflation.
• High inflation is contributing to
– Increasing vulnerability and fall in real income of lower,
middle and fixed income segments of the society.
– uncertainty about future scenario of the business
environment and instability of the financial system
– Erosion of business and investors’ confidence
– Slowing down of real economic activities
• Investment
• Economic growth
• Employment

2
 Trends in Overall CPI Inflation, Food, and Non-Food Inflation
(YoY Basis)

35 General Food Non-Food

30

25
Percen t C h an g e

20

15

10

Month 3
 Trends in CPI Inflation, Food and Non-Food Inflation
(Period Averages)

General Food Non-Food

35
30
P e rc e n t a g e C h a n g e

25
20
15
10
5
0

Period Average
4
 Trends in Overall CPI, Food, Non-Food & Core Inflation

32
28
Overall CPI Food
24
P ercent C hange

20 Non-Food Core
16
12
8
4
0
2001

2002

2003

2004

2005

2006

2007

2008

Jul-A pril.

Jul-A pril.
2008

2009
Year
5
 Inflation Trend in Asia

25

20
Bangladesh China India Pakistan
15
e rc e n ta g e

10

0
2005 2006 2007 2008 2009
-5
6
 Trend in Inflation

20

18

16

14 General Food Non Food

12
P e r c e n ta g e

10

0
FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08
Years

7
• Demand Pull:
– Monetarists: Money supply which is influenced inter alia by
Budget Deficit
– Non Monetarists: Increase in spending in excess of full
employment level
• Cost Push: Increase in cost of factors of production
– Factor prices – oil prices
– Wage increase
– Depreciation of currency
– Interest rate
– Indirect Taxes increase
– Subsidies increase
• Structural: Food shortage 8
ADMINISTRATIVE PRICE CHANGES
• POL Price Changes (%)
• International Domestic
• Feb, 07 – Nov, 08 95.03 51.91
• August – Dec, 08 -102.49 -37.64
• WHEAT Price Changes (%)
• International Support Actual
• 2007-08 70 47.1 43.2
• 2008-09 -33 52.0 51.5
• ELECTRICITY Price Changes
• Rs. 3.07 per unit in July 2008 to Rs. 3.28 per unit in April 2009 (first
100 units)

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• Oil prices
• Electricity Prices
• Wage level
• Daily wages (unskilled and unskilled) increased
• Interest rate (Lending Rate)
• June 07, 10.32% to 12.75% June 2008 to 15.35 in Jan
2009 (5.03% rise) and 14.28 % in March 2009
• Currency depreciation
• $/Rs. 60.36 July 2006, $/Rs. 68.28 June 2008, $/Rs.
81.51 April 2009
• 19.36 percent during current year
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• Budget Deficit
• Rs. 377 bn in 2006-07 to Rs. 777.1 bn in 2007-08
• One of the reason for increase in budget deficit
is rising interest rate
• Interest rate increase: (2007-08 and 2008-09)
Permanent: 4.62%, Floating: 3.65%, Unfunded: 5.46%
• Interest payment: Rs. 369 bn in 2007-08 to Rs. 490 bn in
2008-09 (121 bn rise)
• Domestic Debt: Rs 2610 bn in 2007-08 to 3020 bn in
2008-09 (410 bn rise)
• Bank Borrowing
• Rs 102 bn in 2006-07 to Rs. 520 bn in 2007-08 11
• Core Inflation situation
– 2006-07 5.9
– 2007-08 8.4
– 2008-09 17.9 (March 2009)
• Policy Rate 9.00% in 2005 to 15 % in 2008 then 14%
2009
• Annual Core Inflation is increasing despite Tight Monetary
Policy by the SBP
– Interest rate channel is weak
• Weak effect of policy rate on KIBOR
• Lag in Interest rate pass through
– Price puzzle: rise in interest rate follows rise in prices
• Positive relationship between interest rate and inflation
• The rise in interest rate raises the cost of holding inventories which raises
prices and lowers output
– Rigidity of Core Inflation
• High expected inflation
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• Persistence of inflation
• Change in Money Supply first affects Growth then Inflation
• Monetary Policy effectiveness lag is around 12-18 months.
• Money Supply growth exceeds target level
• Excess Money Supply growth has one-to-one relationship with
Inflation
• Velocity of Money is not constant
Actual and Target Rate of M2 Growth

25

Target Growth
Actual Growth
20
Growth Rate ( %)

15

10

0
1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 13
Year
 Importance of Inflationary Expectations
• Inflationary expectations by firms and employees also play
important role in determining inflation along with labor market
disequilibrium.
• Impact of expected inflation on Inflation (Range 0.56 – 0.93)
• Inflationary expectations are generated by
– High inflation
– Perceived inflation
• Persistence of high inflation generates inflationary
expectations that reinforce inflation through the following
channels:
1. Wage earners: Demand high wages – push up costs for companies –
firms pass this cost to consumers – rising inflation
2. Firms: Increase prices of products expecting inflation to be higher in
future
3. Consumption: If inflation is higher than interest rate then saving
declines and consumption increases.
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• All These Factors Contributed to Inflationary Expectation Spiral
 PIDE - Inflation Expectations Survey (March 2009)
Results

• Inflationary Expectations
Figure 1: Average Expected Inflation In Pakistan

22.5 22
AverageInflation

22
21.5 21
21
20.5 20 20
20
19.5
19
Mar-09 Apr-09 Next six Months Next Year
Time

• Unemployment
– the rate of unemployment will increase in the next six
months and next year
• Growth
– the rate of growth is expected to drop in the next six months.
• Exchange Rate
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– the exchange rate to depreciate during the next six months
• Reduce Expected Inflation
– Improve Policy credibility
– Adopt Inflation targeting
• Reduce Inflation
• Improve monetary and fiscal policies coordination
• Set short term targets
• Inflation and
• Growth
• Choice of Appropriate Monetary Policy Instrument
– Monetary policy instrument
– Intermediate Targets
• Fiscal Authorities set target
– Public Debt level
– Budget Deficit
– Bank borrowing
• Strengthen regulatory bodies to break down monopoly
elements and other arrangements hindering prices to adjust
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