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International Oil Prices and Consumer Prices in Pakistan: Is the Relationship

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Global Business and Economics Review, Vol. 20, No. 4, 2018 389

International oil prices and consumer prices in

Pakistan: is the relationship symmetric?

Syed Tehseen Jawaid*

Applied Economics Research Centre,
University of Karachi,
75270 Karachi, Pakistan
Email: stjawaid@hotmail.com
*Corresponding author

Mohammad Haris Siddiqui

IQRA University,
Karachi-75300, Pakistan
Email: write2haris@gmail.com

Muhammad Shahbaz
Center for Energy Research,
COMSATS Institute of Information Technology,
Lahore, Pakistan
Email: shahbazmohd@live.com

Abstract: This study empirically examines the effect of international oil prices
on aggregated and disaggregated consumer prices in Pakistan by employing
annual time series data for the period of 1981–2011. Cointegration results
confirm the existence of the positive long run relationship between
international oil prices and consumer prices in Pakistan in all models except
clothing and footwear and medical care and health. Furthermore, the error
correction model unveils no immediate or short-run relation between oil prices
and consumer prices. Similarly, our empirical evidence also reveals asymmetric
relationship between international oil prices and consumer prices. Results
indicate that the positive shock in international oil price has a significant
positive effect in all models. On the other hand, negative shock in oil price has
insignificant effect. It is suggested that prevention of cartel, implementation of
antitrust law and reduction in borrowing constraints could be used to tackle the
problem of asymmetric behaviour.

Keywords: consumer prices; oil prices; disaggregated prices; Pakistan;

symmetry.

Reference to this paper should be made as follows: Jawaid, S.T.,

Siddiqui, M.H. and Shahbaz, M. (2018) ‘International oil prices and consumer
prices in Pakistan: is the relationship symmetric?’, Global Business and
Economics Review, Vol. 20, No. 4, pp.389–409.

Biographical notes: Syed Tehseen Jawaid is currently working as an Assistant

Professor/Research Economist in Applied Economics Research Centre,
University of Karachi, Pakistan. His area of interest includes international

Copyright © 2018 Inderscience Enterprises Ltd.

390 S.T. Jawaid et al.

economics, international trade and financial economics. He has also authored

many international research papers in renowned journals like Economic
Modelling, International Migration, Quality and Quantity, Foreign Trade
Review, Journal of Transnational Management, South Asia Economic Journal
and Transition Studies Review and others.

Mohammad Haris Siddiqui studied MBA in Finance at the Iqra University. He

is working as a Finance Professional with a well-known organisation. With
encouragement from his supervisor, he developed keen interest in economics
and writing research articles. He has international research publications in well
reputed journals like Global Business Review and South Asian Economic
Journal.

Muhammad Shahbaz is an Associate Professor in the COMSATS Institute of

Information Technology, Lahore, Pakistan. He has extensively published in
various national and international refereed journals. He also presented many
conference papers in Pakistan and overseas.

This paper is a revised and expanded version of a paper entitled ‘International

oil price and inflation in Pakistan’ presented at International Conference on
Management, Education and Social Sciences Research, Karachi, Pakistan,
4–5 April 2015.

1 Introduction

The effects of international crude oil prices’ shocks on macroeconomic variables such as
inflation and real gross domestic product have appealed many researchers ever since the
ban by the Organization of Petroleum Exporting Countries (OPEC) for the first time in
19731. Although, there is a considerable debate about whether the major cause of
economic downturn are oil shocks2, however, this is commonly believed that the
fluctuations in international oil prices have deterrent effects on inflation to a great extent.
The variations in the world crude oil prices are illustrated in Figure 1. The trend
shows the hikes in oil prices during the 1970s are due to the crisis in the Middle East and
ban on oil by OPEC in 1973. Israel has been in a conflict with Arab countries since 1948
and in October 1973, Syria and Egypt attacked Israel and OPEC imposed a ban on oil and
raised the oil prices as well3. Moreover, the invasion of Iraq by US from 2003 led to the
sharp increase in oil prices and this continued until the end of 2008. It is well evidenced
that crude oil was trading at an average of USD 19.70 per barrel in the 1990s4. The
international crude oil price has risen rapidly from 2002 and reached to USD 90 per
barrel in 2007. This broad fluctuation in international crude oil prices have raised the
eyebrows of policy makers around the globe and many issues have been brought up over
its impacts on macroeconomic performance. It has attracted many researchers to
investigate the effects of world oil prices on inflation particularly in oil importing
countries. It is also noted in various studies that international economic activity is the
leading driver of oil price hikes. Radetzki (2006) reported that the growing demand for
international oil for the most developing countries such as India and China is the primary
reason behind the upsurge in oil price. These two big Asian economies are in the stages
of rapid development and their dependence on the imported oil is far more than the other
 International oil prices and consumer prices in Pakistan 391

developing economies. The emergence of China and India into the global economy
stimulated the increasing demand of oil in global energy markets (Helbling et al., 2008).
Similarly, Hamilton (2009) and Kilian (2009) both reported that increasing demand for
oil in the Asian emerging countries is the factor responsible for the upsurge in oil prices
during the 2000s.

Figure 1 Pakistan inflation rate and world crude oil prices (see online version for colours)

Source: Author’s construction

There are many empirical studies which are devoted to the oil prices implications on
aggregate price inflation5, while others have taken the analysis of effects of oil prices on
disaggregated or commodity level prices at national as well as at international level6. For
the oil importing countries, the fluctuations in oil prices are a real cause of disruption for
their economies and the economy of Pakistan is not the exception. The upsurge in the oil
price exerts severe effects on petroleum products which ultimately affect consumers as
well as producers. From the consumer point of view, the rising cost of crude oil raises
energy bills, while, for the producer, increasing oil price increases the unit cost of
production. While in the case of a decrease in oil prices, reversion may be expected if the
adjustment pattern is symmetric. Unlike most of the studies which are focused on the
economies of the USA and European countries, the present study analyses the effect of
international crude oil prices on inflation for a developing country Pakistan. The case of
Pakistan is interesting in various ways. Being an agrarian economy, it has one of the
largest agricultural sectors and export enormous amount of fruits, vegetables, and other
agricultural raw products. From the time of its independence, Pakistan has an average
GDP growth rate of 5% and an average inflation rate of 8.0% per year. Pakistan also has
gone through the experience of hikes in inflation in 1973 summiting at 38% respectively7.
Oil and gas are the major sources of energy in Pakistan where oil accounts for 32% of
total energy consumption8. Furthermore, due to lack of adequate refining capacity,
Pakistan is heavily dependent on the imports of petroleum products. In the country, the
demand for petroleum products is about 16 Mn tons and only 18% is met through
domestic production while remaining 82% is achieved through imports9. In this regard,
the fluctuations in international oil market can have a direct influence on domestic prices.
392 S.T. Jawaid et al.

So, there seems to be a need to look at the inflationary effects of international crude oil
prices on inflation in Pakistan and it deserves much attention.
In Pakistan, over the past years, the prices of food and other necessities have also
been increased. The high manufacturing and production cost of textile based products
have increased the clothing & footwear prices by 13%. Housing, water and electricity
each raise by 8.7%10. Figure 1 shows the relationship between crude oil prices and
inflation for the period 1970 to 2010. Figure 1 indicates the absence of a concrete
relationship between inflation and crude oil prices. During November 2007, prices of
world crude oil reached to 90$ per barrel and it caused great fluctuations in the
international market11, yet Figure 1 shows it has no significant effect on inflation in
Pakistan.

Figure 2 Relationship between oil prices, food and non-food price (see online version
for colours)

Source: Author’s construction

On the other hand, Figure 2 shows the relationship between food prices and non-food
prices with oil prices. During the period 1986–1988, oil prices seem to be in a declining
phase but food prices seem to increase by 6–11%. Further ahead, the figure clearly
depicts the oil price is constantly rising but the food and non-food price indices seem to
be unaffected. This diagram is also not providing any clear sign of the relationship
between oil prices, and the two price indices. There is considerable ambiguity about
whether the prices of food and other group have increased due to oil price hikes or there
is an internal escalation in domestic prices. Since the previous empirical studies and
theories clearly suggest the causal relationship between international crude oil prices and
inflation, this study intends to investigate the link between world crude oil prices and
inflation along with disaggregated consumer prices that are the major components of
Pakistan’s consumer prices12. In addition to the aggregate price index (CPI), sub-price
indices of consumer prices, specifically, food and beverages (FBV), house rent (HRT),
fuel and lighting (FLT), clothing and footwear (CFT), transport and communication
(TCM) and medical care and health (MCH) are also considered in this study.
Apart from this, we also discuss the oil prices dynamics with inflation to examine
whether the adjustment of consumer prices with oil prices is symmetric or asymmetric. It
 International oil prices and consumer prices in Pakistan 393

has been observed throughout the history of Pakistan’s economy that once the prices are
increased, they never set off or lower down. Theoretically, the decrease in crude oil price
should bring down the prices of fuel and other commodities. Hence, it is necessary to
study the symmetry relation between these variables and it deserves much attention.
There are various empirical studies that document the evidence of the impact of positive
and negative world crude oil price fluctuations on macroeconomic activities13.
The rest of the paper is organised as follows. Some relevant theories and empirical
studies are described in Section 2, followed by methodology and data in Section 3.
Results are presented in Section 4. In Section 5, results are discussed and finally, the
concluding remarks are presented with some policy implications.

2 Review of literature

There are well-known theories that clearly explain the channels through which oil prices
may affect inflation. Some theories and relevant empirical studies are reviewed in this
section.

2.1 Theoretical background

Several economists have provided a number of theoretical explanations to interpret the
relationship between global crude oil price fluctuations and macroeconomic activity. The
relationship between world crude oil prices and inflation is considered as a cause and
effect. When oil prices increase or decrease, inflation follows the same pattern. This is
because of the fact that oil is an essential input to wheel an economy. Oil is a basic
element that is used in most important activities such as fuelling of transportation and
increasing the input cost will consequently enhance the cost of finished products that
leads inflation. Oil prices affect inflation through various ways. Firstly, the increase in the
price of oil raise the production cost and the potential output drops, which shrink the
nation’s aggregate output and ultimately increase the aggregate price (Abel and
Bernanke, 2001; Brown and Yucel, 2002).
Second, terms of trade for an oil importing country are affected by an increase in oil
prices. As a result, wealth is transferred from oil importing country to oil exporting
country which affects the buying power of households and firms in oil importing country
(Dohner, 1981). This slows down production and firms rearrange their labour and capital
structure accordingly. Oil prices hikes may have deterrent effects on investment and
consumption. Investment is affected by increased firms cost and consumption by reduced
disposable income14. A rise in oil prices also increases the demand for money. On the
failure of monetary authorities to meet the rising demand, interest rate rises and there is a
decline in economic activity that affects economic growth (Brown and Yucel, 2002).
Further, Hanson et al. (1993) identified that through exchange rate fluctuations, the
effects of oil prices are transmitted into inflation. It depends heavily on the country
whether it is an oil-importing or oil-exporting nation and its reliance on global trade. A
rise in oil price depreciates the currency of the oil-importing and trade-dependent country
which increases its import bills and ultimately leads to inflation.
On the other hand, the oil-exporting country gains from its foreign exchange in case
of oil price increase which appreciates its local currency. Consequently, the imported
items become quite economical to the oil exporting country but its products become
394 S.T. Jawaid et al.

expensive for other importing countries due to its currency appreciation and consequently
the products of exporting nations become less competitive in the international market.
The gains in income of oil-exporting country are neutralised by a subsequent decline in
the demand for its product. By considering all these numerous ways of impacts, it creates
the impression that the effect of oil price hikes on inflation seems to be an important issue
for a specific nation such as Pakistan.

2.2 Empirical literature on oil price and inflation

There are various time series and cross-sectional studies that have examined the effects of
oil prices on macroeconomic variables like inflation and gross domestic product. Most of
the studies show the inflationary effects of international crude oil price fluctuations on
income (e.g., Hamilton, 1983, 1988, 1996, 2000; Mork et al., 1994; Lee et al., 1995).
These studies have indicated how GDP responds to oil price fluctuations. More
importance has been given to the effects of world crude oil prices on inflation at the
collective level. The prominent studies are Burbidge and Harrison (1984), Hooker (2002),
Barsky and Killan (2004) and Cologni and Manera (2008) providing mix results for oil
price-inflation nexus. Burbidge and Harrison (1984) applied the vector autoregressive
(VAR) framework to analyse the impact of oil prices on industrial production and
inflation for Germany, Japan, the UK, the USA and Canada and found that oil prices have
significant positive impact on Canadian and US consumer prices.
At the same time, the asymmetric behaviour of GDP with oil price is also evidenced
in many studies (see e.g., Mory, 1993; Mork et al., 1994; Ferderer, 1996; Sadorsky,
1999). It is identified that the macro-economic variables behave asymmetrically to world
crude oil price fluctuations. For example, Mehrara (2008) empirically identifies the
asymmetric relationship between economic activity and oil revenues for 13 countries
namely – Algeria, Colombia, Ecuador, Indonesia, Kuwait, Iran, Saudi Arabia, Qatar,
Libya, UAE, Nigeria, Mexico and Venezuela using annual data for the period
1965–2004. The results confirm that income is negatively affected by negative oil shocks
whereas positive oil shocks have a very minor role in accelerating economic growth.
Reaffirming these results, Lardic and Mignon (2008) determine the relationship between
economic activity and oil prices for US, G7, Europe and Euro area countries. Their
results show the presence of asymmetry between oil prices and GDP.
Recently, Ibrahim and Chancharoenchai (2014) analyse the effects of oil prices on
inflation at aggregate as well as disaggregated level in Thailand. They note the
asymmetric relationship in consumer prices, non-food and beverages prices, and housing
prices. Cunado and Pérez de Gracia (2005) investigate the effects of world crude oil
prices on consumer prices and economic activity for six Asian countries namely – Japan,
South Korea, Malaysia, Thailand, Singapore, and the Philippines. Their results indicate
that the world crude oil prices significantly affect economic activity and consumer prices.
They note that inflationary effects are more when the shocks of oil prices are defined in
local currencies. Kiptui (2009) identifies the relation of oil prices with inflation for Kenya
and confirms that oil prices have significant positive effect on inflation. Kiptui also notes
that inflation is also affected by exchange rate movements. Similarly, Alghalith (2010)
investigates the oil price impact on food prices for Trinidad and Tobago and indicates
that higher oil prices raise food prices. Mallik and Choudhry (2011) determine the effect
of growth uncertainty and oil price on inflation and economic growth in Australia. Their
results indicate that oil price changes significantly increase inflation.
 International oil prices and consumer prices in Pakistan 395

Ibrahim and Said (2012) analyse the relation between international oil prices and
inflation for Malaysian economy. They use aggregate consumer prices and other
consumer prices to identify if they are related to oil prices. They found the presence of
cointegration with oil price, aggregated consumer price and food indices. Their results
also unveil that oil price changes significantly affect rent, fuel and power, food, and
transportation and communication prices. Most recently, Belke and Dreger (2013)
investigate the effects of oil and food price movements to consumer prices in Middle
East-North African (MENA) countries by applying the threshold cointegration approach.
They note that domestic prices are affected in the long-run by an increase in food and oil
prices. Hooker (2002) identifies the breakdown in the core US inflation and observed that
oil price effect on inflation has become insignificant during 1980 by including Philips
curve to include the oil price. De Gregorio et al. (2007) conduct a study for 37 countries
using a Philips curve model by introducing oil price. They find the insignificant effect of
oil prices on inflation in many industrial countries and minor effects in the emerging
countries.
Chen (2009) examines the effects of oil prices on inflation for 19 industrialised
economies by using Johansen cointegration approach. Their results indicate the
insignificant effects of oil price for all the countries which indicate that the appreciation
of the domestic currency and greater extent of trade openness are the driving force for the
declining effects of oil into inflation. Baffes (2007) scrutinises the influence of world
crude oil prices on the costs of 35 global commodities for the period from 1960–2005 by
applying the linear regression model. The results show that a 10% increase in world
crude oil prices is accompanying 1.8% rise in food prices. Harri et al. (2009) investigate
the relationship between commodity prices, oil prices, and exchange rates. They find that
cointegration exists between commodity prices and crude oil prices while cotton, soybean
and corn are significantly affected by international oil prices.
Chen et al. (2010) empirically examine the relationship between international crude
oil price and the global prices of grain including corn, wheat, and soybean by applying
the bounds testing approach. Their results indicate that prices of grain are significantly
affected by fluctuations in crude oil prices. Cha and Bae (2011) empirically study the
effects of crude oil prices on bioethanol and corn market in the USA by applying a
structural vector auto-regression model (SVAR). Their empirical evidence shows that the
hikes in the price of oil increases the bioethanol demand and raises the price for corn.
Nazlioglu and Soytas (2012) examine the relationships between international crude oil
prices and 24 global agricultural goods prices by applying panel cointegration and
causality approaches. They find that food commodity prices are significantly affected by
international crude oil prices.
On contrary, Qiu et al. (2012) applied a structural VAR using oil prices, food prices,
and consumer prices. They observe that gasoline, ethanol and oil market shocks do not
have any effect on grain markets. Similarly, Reboredo (2012) empirically identifies the
causal relationship between global food prices and international oil prices and finds the
neutral relationship between the series. Wang et al. (2014) empirically investigate the
influence of oil price movements on agricultural goods prices by focusing on nine major
agricultural commodities such as soybean, corn, cotton, cocoa, barley, rice, wheat, tea
and coffee, and Brent crude oil. They apply the structural VAR (SVAR) and find that
agricultural commodity prices are not significantly affected by oil supply and oil demand
shocks. Jaffri et al. (2014), empirically examine the nature of pass-through of global food
inflation to domestic food inflation in Pakistan by using monthly data from 1993M2 to
396 S.T. Jawaid et al.

2012M2. Their empirical evidence reveals the asymmetric behaviour of domestic food
inflation to global food inflation. The scope of the study is limited to food inflation only.
This sets the background and the need for further research and hence, we take a further
step to identify the asymmetric behaviour of food price and other consumer prices with
international oil price in Pakistan.
Ajmi et al. (2015) examine the relationship between oil price and consumer prices in
South Africa by employing long time series data from 1921 to 2013. Results suggest that
causal relationship exists between oil prices to consumer price in short run. Cointegration
result indicates no long-run relationship exists among the variables. The asymmetric
analysis shows that positive oil price shock lead positive shocks in domestic prices.
We have observed that oil price variations have different effects on inflation and
other sectors. Some studies show the positive and significant effect of oil prices on
inflation while others report the negative and insignificant impact of oil prices on
inflation. It can also be argued that oil price movements may have inflationary
consequences to a specific commodity or a country. Since oil is the second major source
of energy and Pakistan is highly dependent on imported oil15, therefore the global oil
price fluctuations can have a direct effect on domestic oil prices. In this way, the aim of
this study is to analyse the impact of international oil price volatility on consumer prices
in Pakistan.

3 Empirical framework

By reviewing various empirical studies, the model to predict the effect of oil prices on
inflation is defined as follows:
INFt = β 0 + β1GDPt + β 2 OPRt + μt (1)

where INF represents inflation measures by consumer price index (aggregate and
disaggregate both) and GDP is real gross domestic product, OPR is international oil
prices and ε is the error term assumed to be normally distributed. Additionally, effect of
oil prices on sub-price indices namely; food and beverages (FBV), house rent (HRT), fuel
and lighting (FLT), clothing and footwear (CFT), transport and communication (TCM),
and medical care and health (MCH) is also considered. The yearly time series data are
used for the period of 1981–201116. Due to non-availability of data, the time period is
restricted to 1981–2011. UK Brent crude oil price has been used as an indicator of world
crude oil prices17. All the data is expressed in logarithm form and gathered from
various issues of Pakistan Economic Survey and official website of World Bank
(http://data.worldbank.org/data-catalog/world-development-indicators).
Augmented Dickey-Fuller (ADF)18 and Phillip-Perron (PP)19 unit root test are used to
test the stationary properties of the variables for a long-term relationship. Johansen and
Juselius (1990) co-integration technique is used to examine the long-run relationship of
consumer price index with crude oil prices. The null hypothesis of co-integration test is
that there exists no co-integration between the variables. If the null hypothesis of
cointegration is rejected, it confirms the existence of long-run relationship between the
 International oil prices and consumer prices in Pakistan 397

variables. For reliability and validity of applied econometric procedure, there are number
of studies like Waheed and Jawaid (2010), Jawaid and Haq (2012), Jawaid and Raza
(2012, 2013, 2015, 2016), Jawaid (2014) and Jawaid et al. (2016) amongst others who
have used the same unit root and cointegration test for almost same sample size not only
for Pakistan but also other similar developing countries like India, Nepal, Sri-Lanka and
Bangladesh. For coefficients, ordinary least square (OLS) estimation procedure has been
used20. On the other hand, to estimate the short-run relationship between the variables, we
use error correction model as proposed by Hendry (1990). Furthermore, in addition to
equation (1), we also investigate the symmetric effects of oil shocks on overall inflation.
It is well-documented in many studies that most macro-economic variables are likely to
respond asymmetrically across business cycle (Mory, 1993; Mork et al., 1994; Tsai et al.,
2012). To identify the relationship between inflation and oil price whether it is symmetric
or asymmetric, we follow the approach based on Hamilton (1996) methodology.
According to this method, the oil shocks are generated into positive and negative oil
shocks series. It defines the net oil price in the given manner:
For positive shocks:

OPRt+ = Max {0, Pt − Max{Pt −1 , Pt − 2 , Pt −3 , Pt − 4 }}

For negative shocks:

OPRt− = Min {0, Pt − Min{Pt −1 , Pt − 2 , Pt −3 , Pt − 4 }}

According to Hamilton (1996), it is more accurate to compare the present price of oil
with the preceding months. If the difference between the present price of oil and the
maximum value of previous months is positive, the positive oil shock is said to have
occurred, otherwise zero. In the case of the negative oil shock, the minimum value is
considered and only if the difference is negative, otherwise there is no oil shock said to
have occurred. To estimate the symmetry relation of oil price with inflation, we follow
the same approach as presented above by formulating the oil price shocks into positive
and negative series. Thus, we have below equation to estimate whether the relationship of
oil price and inflation is symmetric or asymmetric:
INFt = α 0 + α1OPRt+ + α 2 OPRt− + μt (2)

where INF denotes inflation (aggregate and disaggregate), OPR+ is the oil price increase
and OPR– is the oil price decrease and µ is the error term. We also estimate the inflation
dynamics on other price indices to identify what behaviour they exhibit in Pakistan in
response to the movements in oil prices. For reliability and validity of the economic
procedure for an asymmetric relationship, it is noted that Ibrahim and Said (2012) have
used the same methodology to find an asymmetric relationship between oil price and
inflation. Side by side, Mehrara (2008) and Cong et al. (2008) have also used the same
methodology to find an asymmetric relationship between oil revenue and economic
activities. As far as the limitation is concern, these analysis does not indicate a structural
break in the series neither in unit root test and nor in cointegration as well.
398 S.T. Jawaid et al.

4 Estimations and results

To test the unit root properties of variables, we apply ADF and Phillip-Perron (PP) unit
root tests. The results ADF and PP tests are reported in Table 1. These tests are employed
on the level of variables and then on the first difference.
Table 1 Stationarity test results

ADF test statistics PP test statistics

Variables Level First difference Level First difference
C C and T C C and T C C and T C C and T
OPR 0.94 –1.79 –5.87 –6.58 2.36 –1.38 –5.92 –15.92
GDP –2.50 –2.29 –3.39 –3.70 –2.12 –2.12 –3.36 –3.70
CPI 1.19 –2.22 –3.08 –3.39 0.81 –1.60 –2.65 –15.84
FBV 1.63 –1.56 –3.10 –3.57 1.00 –1.35 –3.31 –3.73
HRT 0.39 –1.10 –3.14 –3.35 1.21 –1.73 –3.49 –3.81
FLT 1.86 –1.70 –3.97 –4.45 1.70 –1.83 –3.97 –4.45
CFT –0.83 –2.06 –2.87 –4.06 –1.05 –1.59 –2.88 –16.73
TCM 0.38 –2.59 –6.42 –6.34 0.65 –2.87 –7.61 –7.91
MCH –0.04 –1.29 –3.98 –3.89 –0.16 –1.75 –4.16 –4.08
Notes: OPR – oil price; GDP – real gross domestic product; CPI – consumer price;
FBV – food and beverages; HRT – house rent; FLT – fuel and lighting;
CFT – clothing and footwear; TCM; transport and communication;
MCH – medical care and health. The critical values for ADF and PP tests with
constant (C) and with constant and trend (C and T) at 1%, 5% and 10% level of
significance are –3.711, –2.981, –2.629 and –4.394, –3.612, –3.243 respectively.
Source: Author’s estimation
The results reported in Table 1 indicate the acceptance of null hypothesis that confirms
the presence of unit root in the variables at level with intercept and trend. All the
variables are found stationary at first difference. It signifies that the series of variables
can possibly depict long run relationship. For this, we apply Johansen and Juselius (1990)
cointegration method to evaluate the long run relationship. This method is suitable once
variables have a unique order of integration. The calculated and critical values of trace
statistics and maximum eigen value statistics are reported in Table 2.
The results reject the null hypothesis of no cointegration among the variables for all
price indices in Pakistan at 5% level of significance (Table 2). This leads us to accept the
alternate hypothesis of cointegration between the series. We may confirm the existence of
long-run relationship between the variables. We estimate the long-run impact of
independent variables on a dependent variable by using OLS. In order to correct the auto-
correlation, we use Newey-West HAC procedure. This approach rectifies the
autocorrelation as well as corrects heteroscedasticity if it is present21. The results are
reported in Table 3.
The models predicts sensibly well with values of adjusted R2 which are higher than
0.95 and F-statistic is significant. The results exhibit the positive and significant effect of
 International oil prices and consumer prices in Pakistan 399

oil prices on consumer price, food and beverages, house rent, fuel and lighting and
transport and communication. On the contrary, the insignificant effect of oil price is
found with medical care and health and clothing and footwear. It can be seen that in the
long-run, the effect of oil price on fuel and lighting is larger than the other price indices.
This concludes that if oil prices are increased by 10%, it will increase fuel and electricity
prices by 1.9%. Similarly, housing sector seems to be most affected by the fluctuations in
oil prices. To examine the short-run relationship, we use general to specific approach
proposed by Hendry (1980). The results are shown in Table 4.
Table 2 Johansen cointegration test results

Hypothesis Trace 5% critical Maximum eigen 5% critical

Models
no. of CE(s) statistics values value statistics values
Model 1 CPI None 29.6358 24.27596 19.29336 17.7973
At most 1 10.34245 12.3209 9.497675 11.2248
At most 2 0.84477 4.129906 0.84477 4.129906
Model 2 FBV None 32.12882 24.27596 19.91395 17.7973
At most 1 12.21486 12.3209 10.97495 11.2248
At most 2 1.23991 4.129906 1.23991 4.129906
Model 3 CFT None 34.23203 24.27596 23.94908 17.7973
At most 1 10.28295 12.3209 9.959651 11.2248
At most 2 0.3233 4.129906 0.3233 4.129906
Model 4 HRT None 29.49013 24.27596 20.13306 17.7973
At most 1 9.357063 12.3209 8.932845 11.2248
At most 2 0.424218 4.129906 0.424218 4.129906
Model 5 FLT None 41.50185 24.27596 28.85249 17.7973
At most 1 12.64936 12.3209 12.17031 11.2248
At most 2 0.479048 4.129906 0.479048 4.129906
Model 6 TCM None 37.04698 24.27596 22.74872 17.7973
At most 1 14.29826 12.3209 13.47186 11.2248
At most 2 0.826402 4.129906 0.826402 4.129906
Model 7 MCH None 38.54144 24.27596 27.47869 17.7973
At most 1 11.06275 12.3209 10.66249 11.2248
At most 2 0.400261 4.129906 0.400261 4.129906
Source: Author’s estimation
The value of the coefficient of error term depicts a negative sign and is significant which
suggests that the model obtains the equilibrium value. Similarly, the results indicate that
there is no short-run relationship of oil price with all price indices along with the
aggregate CPI. This is true because as a commodity, the demand for oil is price inelastic.
The change in oil prices does not bring any change in the quantity demand. People cannot
immediately change their consumption patterns, through buying more fuel efficient cars
or any other changing behaviour that affect consumption.
 400

Table 3

CPI FBV CFT HRT

S.T. Jawaid et al.

Coeff. t-stats Prob. Coeff. t-stats Prob. Coeff. t-stats Prob. Coeff. t-stats Prob.
C –18.065 –9.7025 0.0000 –19.001 –9.3944 0.0000 –19.761 –14.099 0.0000 –14.045 –7.657 0.0000
GDP 1.4351 9.4946 0.0000 1.4862 9.0204 0.0000 1.6122 14.078 0.0000 1.1504 7.7585 0.0000
OPR 0.1147 1.8024 0.0822 0.1391 1.9398 0.0625 –0.029 –0.5976 0.5549 0.1545 2.5807 0.0154
Adj. R2 0.9772 0.9752 0.9770 0.9739
F-stats (prob.) 0.0000 0.0000 0.0000 0.0000
FLT TCM MCH
Coeff. t-stats Prob. Coeff. t-stats Prob. Coeff. t-stats Prob.
Long run determinants of consumer prices

C –18.155 –8.3048 0.0000 –19.802 –19.549 0.0000 –17.281 –7.2309 0.0000

GDP 1.4050 8.0061 0.0000 1.5523 18.679 0.0000 1.4251 7.3451 0.0000
OPR 0.1951 2.7555 0.0102 0.1136 3.0376 0.0051 0.0225 0.2857 0.7772
Adj. R2 0.9743 0.9868 0.9530
F-stats (prob.) 0.0000 0.0000 0.0000
Source: Author’s estimation
 Table 4

FLT TCM MCH

Variables
Coeff. t-stats Prob. Coeff. t-stats Prob. Coeff. t-stats Prob.
C 0.1174 3.6105 0.0014 0.1008 2.8132 0.0096 0.1043 3.3462 0.0027
ΔINF(–1) 0.178 0.9857 0.3341 0.0077 0.0256 0.9798 0.1131 0.6009 0.5535
ΔGDP –0.9591 –2.0033 0.0566 –0.2509 –0.5156 0.6108 –0.9268 –1.8463 0.0772
ΔOPR –0.03600 –1.075 0.293 –0.04800 –1.3432 0.1917 –0.02120 –0.6054 0.5506
ECT(–1) –0.17287 –2.4602 0.0215 –0.2409 –2.1839 0.039 –0.1688 –2.5129 0.0191
D.W. stats 2.352 2.119 2.1196
Adj. R2 0.3031 0.1514 0.194582
Results of error correction model

Prob (F-stats) 0.01202 0.09359 0.05526

CPI FBV CFT HRT
Variables
Coeff. t-stats Prob. Coeff. t-stats Prob. Coeff. t-stats Prob. Coeff. t-stats Prob.
C 0.0618 3.1255 0.0046 0.0846 3.288 0.0031 0.0444 2.0958 0.0468 0.0263 1.5661 0.1304
ΔINF(–1) 0.5116 3.6032 0.0014 0.4183 2.7145 0.0121 0.4272 2.4601 0.0215 0.6948 5.5961 0.0000
ΔGDP –0.5117 –1.8358 0.0788 –0.8291 –2.0296 0.0536 –0.0254 –0.0887 0.9301 –0.1179 –0.4884 0.6297
ΔOPR –0.0007 –0.0366 0.9711 0.0188 0.639 0.5289 –0.0162 –0.7857 0.4397 –0.0007 –0.045 0.9645
ECT(–1) –0.1696 –3.4415 0.0021 –0.215 –3.1958 0.0039 –0.1304 –2.3585 0.0268 –0.1513 –3.5221 0.0017
International oil prices and consumer prices in Pakistan

D.W. stats 2.321 2.163 1.919 1.578

Adj. R2 0.5052 0.3808 0.2924 0.6298
Prob (F-stats) 0.0002 0.0033 0.0141 0.0000
Source: Author’s estimation
401
 402

Table 5

CPI FBV CFT HRT

Variables
S.T. Jawaid et al.

Coeff. t-stats Prob. Coeff. t-stats Prob. Coeff. t-stats Prob. Coeff. t-stats Prob.
C 4.1201 17.248 0.0000 4.1072 12.605 0.0000 4.1068 18.394 0.0000 4.1595 19.519 0.0000
Symmetry test results

ΔOP+ 0.0909 4.0255 0.0004 0.0996 4.7127 0.0001 0.0758 3.3451 0.0024 0.0810 4.1374 0.0003
ΔOP– 0.0509 1.6810 0.1039 0.0547 1.6256 0.1152 0.0437 1.5553 0.1311 0.0449 1.6723 0.1056
Adj. R2 0.2121 0.2264 0.1750 0.2095
Prob. (F-stats) 0.0135 0.0104 0.0257 0.01416
FLT TCM MCH
Variables
Coeff. t-stats Prob. Coeff. t-stats Prob. Coeff. t-stats Prob.
C 4.1224 9.6543 0.0000 4.1293 15.956 0.0000 4.1453 19.3273 0.0000
ΔOP+ 0.1000 3.7757 0.0008 0.0933 3.7803 0.0008 0.0739 3.5774 0.0013
ΔOP– 0.0571 1.5407 0.1346 0.0503 1.5622 0.1295 0.0450 1.6431 0.1115
Adj. R2 0.2126 0.1912 0.1805
Prob. (F-stats) 0.0133 0.0195 0.0234
Source: Author’s estimation
 International oil prices and consumer prices in Pakistan 403

4.1 Test for symmetric relationship between oil price and consumer prices
When the OLS estimation is applied to check the symmetric relation, the asymmetric
effect is prominent among all the price indices as shown in Table 5.22
The results indicate that positive shocks are significant while negative shocks are
insignificant in all the price indices. In other words, we can say that the boom in world oil
prices increases the overall prices as well as all the other prices but the decline in oil
prices does not offset or bring down the prices of other sectors and the aggregate price as
well23. The negative shocks do not matter much but positive shocks do. So, it is
evidenced that all the price indices tend to behave asymmetrically with oil prices in
Pakistan.
Theoretically, this asymmetry in inflation can be related to downward rigidity in
nominal wages. If there is an increase in oil prices, the production is decelerated by the
firms or the increased production cost is transmitted to consumers. On the contrary, the
decline in oil prices does not bring down the production cost and the cost remains high
due to downward rigidity in labour market and public taxes. It is reported in many studies
that the prices of petroleum products tend to behave asymmetrically to change in crude
oil prices (e.g., Bacon, 1991; Balke et al., 1998). The prices of gasoline tend to rise
rapidly when crude oil price rises but on the contrary, they do not fall with the decline in
crude oil prices. These could be some possible explanations to support the evidence for
the asymmetric behaviour of oil price with inflation.

5 Conclusions and policy recommendations

Being one of the major energy sources, oil plays a vital role in economic, political, and
social aspects of a nation. Oil prices and inflation are always related in a causal way and
follow the same pattern. In this paper, we attempt to empirically investigate the effects of
oil prices on inflation and other consumer prices for the period of 1981–2011. We
examine which sector can get most affected by the changes in oil prices by analysing
sub-indices of aggregate inflation, namely, food and beverages, house rent, fuel and
lighting, transport and communication, clothing and footwear, and medical care and
health along with aggregate inflation.
The findings confirm the inflationary effect of oil prices with all the price indices
except medical care and clothing and footwear prices. The effect of oil prices on fuel and
lighting seems to be the strongest. The driving forces behind medical care and clothing
and footwear prices might be different from those affecting the other indices. Economic
factor also plays a very significant role in the prices of the clothing industry. During the
economic boom, people have more disposable income and they may shop for more
clothing, thus increasing the sales. Contrarily, sales for these clothing entities may drop
down during the recession, resulting in a stock surplus. As a consequent, these
inventories have to be sold at lower prices. The clothing manufacturers also have to sell
their brands at comparatively lower prices to stay in competition with other brands.
Oil prices and real GDP are not only cointegrated with inflation but with all the price
indices. Additionally, the asymmetric inflationary effect of oil prices is also noted with
all the sectors. One of the major explanations for this outcome can be related to the
downward rigidity in labour markets and public taxes. If there is an increase in the prices
of commodities due to oil price hike, the market expects that the trend will continue in
404 S.T. Jawaid et al.

future, this will keep the prices high no matter even if there is a decline in oil prices and
the wages remain high. Similarly, the government imposes heavy taxes on petroleum
prices and due to high taxes, the drop down in crude prices are not transmitted in
domestic prices.
From these findings, we propose that the inflationary consequence of oil prices is
mostly from fuel and lighting prices. As Pakistan is an oil importing nation and almost
82% of petroleum products are imported to meet the rising demand, so oil price
fluctuations will have a devastating effect on the energy sector and on domestic prices.
This scenario highlights the unstable future for the macroeconomic condition of Pakistan
following the oil price shocks. There is a strong need for policy makers to formulate such
a policy to focus on alternative sources of energy so that heavy dependency of the
country on imported oil could be reduced in order to combat inflation. Further
exploration of natural resources particularly of oil and gas and adequate availability of
electricity for the purpose of productivity would have a positive effect on production and
price level in the long run. Moreover, the problem of electricity can also be tackled
through coal sector. Coal is widely used for generating energy across the world.
Pakistan’s neighbouring countries particularly China and India generate 63% and 47% of
their electricity from coal and the share of coal in Pakistan’s energy mix is very low at
6% despite having the second largest reserves in the world of about 187 billion tons
[Pakistan Economic Survey, (2013–2014), p.221].
Various measures can be adopted to tackle the asymmetry adjustment. These include
a reduction in oil imports and improvement of domestic refining capacity. In addition to
this, the government should adopt flexible policies and subsidise by reducing heavy taxes
on gasoline and fuel prices, so that the decline in crude oil price should be reflected in
local prices. Moreover, the government can also apply the antitrust law (also known as
competition law) in order to provide free and open markets in the economy to maintain
competition in the market and prevent the formation of a cartel. The cartel if formed will
have control on the production and on the prices due to monopoly. The decline in
international oil price will not be reflected in domestic prices and on the contrary, the
positive shocks of oil will increase the overall prices and the oil industry will be at
serious risk.
Keeping in view the uncertainty in the level of economic activity, there is a need for
cautious expenditure projections. Policy makers should propose an adjusted budget for
expenditures on oil to be slightly higher than the normal. If oil prices are increased, the
surplus amount of the budget can be utilised to offset the effect of increased price.
Similarly, policy makers should focus on the development of money markets and reduce
the borrowing constraints so that credit is easily available at the time of oil price hikes
and the producers could smoothly run the production instead of slowing it down. For
foreign investors, Pakistan is a very lucrative market having more than 194 million
consumers. People need basic necessities like food and energy in order to spend their
lives. Power, infrastructure, and natural resources have great potential. There is a great
opportunity for investors in coal-based power projects, substitute energy like solar energy
and wind power and transmission of natural gas from a foreign land. Development in
infrastructure and exploration of its natural resources are also needed. The investors can
exploit all these opportunities.
We recommend that the government should take measures to resolve the problem of
energy shortages and improve law and order situation of the country to provide more
investment friendly environment to investors to restore their confidence. Policies should
 International oil prices and consumer prices in Pakistan 405

be directed towards agricultural sector to bring a reduction in the unit cost of food. It can
be made possible by the adequate land administration, water management and improving
the supply and marketing channels of food products. Availability of agricultural credit to
poor farmers can also help them to utilise advance technology which can ultimately
enhance the productivity.

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Notes
1 See Hudson and Jorgenson (1978) and Mork and Hall (1979).
2 See Bohi (1989).
3 US Department of State: Office of Historian.
4 See Ibrahim and Said (2012).
5 See Balcilar et al. (2014) and Yoshizaki and Hamori (2013).
6 See Gao et al. (2014) and Wang et al. (2014).
7 Pakistan Economic Survey (2012–2013), p.92.
8 Pakistan Economic Survey (2013–2014), p.219.
9 See Malik (2007).
10 Pakistan Economic Survey (2013-2014), p.108.
11 See Cong et al. (2008).
12 The information is obtained from the official website of Ministry of Finance, Government of
Pakistan http://www.finance.gov.pk.
13 See Hamilton (1996), Mehrara (2008), Ibrahim and Said (2012), Ibrahim and
Chancharoenchai (2014) and Nazariyan and Amiri (2014).
14 Lardic and Mignon (2008).
15 See Malik (2007).
16 Monthly data for GDP and price indices is not available for Pakistan for considered sample
period.
 International oil prices and consumer prices in Pakistan 409

17 Other oil prices include world average oil price, WTI crude oil price and Dubai crude oil price.
Due to availability of data for our required period, we use Brent crude oil price as it is also
employed in almost all the other research papers as well.
18 See Dickey and Fuller (1979).
19 See Phillips and Perron (1988).
20 Rehman and Shilpi (1996) argue that OLS procedure is appropriate in case of less than
100 observation.
21 Gujarati and Porter (2009), pp.452–453.
22 Both positive and negative shock series of oil prices are stationary at first difference, i.e., I(1).
23 Our findings are consistent with Güney and Hasanov (2013), who reported asymmetry of oil
price with inflation and Ibrahim and Chancharoenchai (2014), who document asymmetry with
aggregate inflation, non-food and housing sector.

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