Co-integration in inflation rates of the SAARC countires

By
Maaz Faridi (10352)
Shayan Rafi Ahmed (9597)
Mohammad Fahad Umer Shaikh (10149)
Syed Hakkas Shaukat Ali (9062)
Jazib Zahid (9045)
Imran Iqbal (5865)

A research submitted in partial fulfillment of the requirements for the degree of Bachelors of
Business Administration to Iqra University Research Centre (IURC) at the Iqra University, main
campus, Karachi.

Karchi, Pakistan
APRIL, 2012

Co-Integration In The Inflation Rates Of SAARC Countries

ABSTRACT
The purpose of this study is to find out the co-integration in the inflation
r a t e s o f t h e S A A R C c o u n t r i e s n a m e l y, P a k i s t a n , I n d i a , S r i - L a n k a , B h u t a n ,
Nepal, Maldives and Bangladesh. The statistical test Johansson
Multivariate Co-integration test is applied on the 30 yearly observations
of the interest rates of the 7 SAARC countries and the conclusions were
that there is co-integration in the inflation rates of the three SAARC
c o u n t r i e s n a m e l y, P a k i s t a n I n d i a a n d S r i - l a n k a b u t r e s t o f t h e S A A R C
countries inflation rates are not co-integrated.

Chapter 1: Introduction
1.1 Overview
As seen many people have tried to cover the topic for the inflation rate in different
countries individually but they havent co-integrated it in a separate manner. The purpose of this
research is to investigate whether there is a co-integration between SAARC countries on the
basis of their inflation rates and how they are related to each other.
It has been indicated by the several research paper that the SAARC countries economy is cointegrated and correlated to each other but it is also very important to study either south asian
stock market also co-integrated or not. Subhani, Meher and Osman (2001) indicated in their
research paper that the south asian stock market namely, India (Bombay stock
exchange),Bangladesh( Dhaka stock exchange), Nepal (Nepal stock exchange and Pakistan
(Karachi stock exchange) are not co-integrated and there is no co-movements in the stock market

Co-Integration In The Inflation Rates Of SAARC Countries

of these four countries but there is a co-integration and co-movements in the stock market of
Bangladesh(Dhaka stock exchange) and Pakistan(karachi stock exchange).
Devatharan (2008), revealed that SAARC countries i.e Srilanka, Bhutan, Nepal, India, Pakistan,
Maldieves and Bangladesh are higly interdependent on each other. This research paper uses GDP
as a indicator and applies Granger non casualty test in order to prove that SAARC countries are
highly interdependent and their GDP and economical status also depend on each other. This
research paper also entails the correlation of GDP and the inflation rates of the SAARC countries
have strong interdependence on each other.
If the stock markets, GDP and Inflation of some SAARC countries are co-integrated as stated
above, so the purpose of this research is to investigate if there is a co-integration of inflation rates
present in between SAARC countries or not.

1.2 Problem Statement:

To study the Co-integration of Inflation rates in SAARC Countries.

1.3 Proposed Hypothesis:

H0: There is co-integration of inflation rates of SAARC countries.

1.4 Objective Of Research Study:

The objective of the research is to study the relationship in the inflation rates of the 7
SAARC countries that are;
Pakistan
Sri Lanka
India

Co-Integration In The Inflation Rates Of SAARC Countries

Maldives
Bhutan
Bangladesh
Nepal

Chapter 2: Literature Review

The research of Peiris, Ding and Anand (2011), the study includes the country which is
recognized by the South Asian Association of Regional Cooperation that is Sri Lanka and is also
related to the model in inflation. The study implies forecasting and policy analysis system that is
actually FPAS which is to know the inflation on the country. The study provides that the inflation
can reduce the macroeconomic instability and the shocks that is faced by the economy. Sri
Lanka, as research conducted can face a broader inflation side because of its weakness in supply
side shocks and its exchange rate policy.
The research conducted by Abbas, Akbar, Nasir, Aman Ullah and Naseem (2011), on the Impact
of Foreign Direct Investment on Gross Domestic Product which is actually related to the
countries which are related and recognized by the South Asian Association of Regional
Cooperation. The paper implies the GDP of SAARC countries and the outcome was conducted
by a multiple regression processes. The data acquired was from the year of 2001 to 2010. The

Co-Integration In The Inflation Rates Of SAARC Countries

result is significant and as conducted, shows that there is a positive relationship among the Gross
domestic product and the foreign direct investment of the country and a negative and
insignificant relationship among the gross domestic product and the inflation. It is very important
to discover is there any effect and impact of foreign investment on the GDP of the SAARC
countries. This paper investigate the effect of foreign investment of the GDP of the SAARC
countries the GDP of any country is a back bone for the economy it is very important that the
GDP of the country should be well stable. This research shows that the GDP and the FDI are
directly proportional to each other and inflation and GDP are inversely proportional to each
other. The more GDP is well stable the more FDI will come the country and the more GDP is
well stable the less inflation will be and the less GDP is the more will be inflation rate of the
country
The study conducted by the Zaman, Khan, Ahmad and Ikram (2011), implies the Inflation,
Unemployment and the NAIRU in Pakistan and is also based on the Pakistan which is a country
recognized by SAARC. The research is based on the data of from 1975 to 2009 and the Phillips
curve approach is used. The curve shows relationship between unemployment and inflation and
as the research is conducted the relationship between these two units are found as negative
relationship, thus if the unemployment is going to reduce then it would actually raise the price
level for the economy. So, as the research conducted by The Hussain and Malik (2011), they also
showed as this research that Pakistan has a long run and has a casual relationship between
unemployment and inflation. So, the end conclusion remains that the inflation in Pakistan
decreases the unemployment.
The study of Banik, Biswas and Criddle (2008), conducted on Optimum currency area in South
Asia and it implies the study related to the economic conditions in South Asia. The study

Co-Integration In The Inflation Rates Of SAARC Countries

conducts on a search that the South Asian countries would go better if every country has the
same economic structures and are similar than they would be considered as the good candidates.
The research conducted by Samantaraya (2009), on a topic of exchange rate pass which is related
to the inflation in India which is a registered country by the South Asian Association of Regional
Cooperation (SAARC). The study implies that the exchange rate and speeding prices of India is
creating a major widespread in their policy and it is the major reason of inflation creating in the
country. It is said that the international economics interest of knowing a long old question on
domestic prices of India, related to exchange rate was still been questioned. As it is seen that
there was a moderation and stability in the countrys inflation and there wasnt any variations in
the exchange rate of the country. So as the research says the there is a relationship between the
exchange rate and inflation in the country and its is questioned that how the exchange of these
two takes place as directly or indirectly. However, the research was not found to be supportive to
study the exchange rate as a useful matter regarding the solution to the inflation in the country.
The research conducted by Zubayer and Alam (2010), presented the inflation condition with
respect to Bangladesh. The study implies the empirical literature in order to reduce the cost of
trade between partner countries and provides a system of regional integration in South Asian
Union and seven countries in South Asia. Very low levels in the context of intra-regional trade (at
least 5%) and the main source of foreign direct investment is flowing into overseas. Despite the
major differences between the various member countries. The possibility of foreign direct
investment flows between countries in the region.
The research conducted by Khan, Arshad and Sajid (2007) on the topic of Integration of
Financial Markets in SAARC countries. The study implies that the SAARC countries monitor
four United Nations publications, using the state to information about the interest rate gap

Co-Integration In The Inflation Rates Of SAARC Countries

between the links. The actual interest rate and U.S. interest rates and a unique co-integrating
vector between the North by the recommendations of SAARC. Conversely, India's status, the
foreign interest rate adjustment factors related to causality cofactors are two possible values from
a remote UIP. Co integration test are applied to SAARC countries. Co integrating vectors in the
test results suggest the importance of market integration. Moreover, long-term interest rates
abroad, and other interest rate on the interest rates in Pakistan have a positive impact. Short term,
the model assumes that the error changed.
As far as inflation rate of Pakistan is concern several researches have been conducted on this
particular topic. Saleem (2010) presented a research article on the inflation rate of the Pakistan
which discuss several conditions which are responsible for increasing of the inflation rate in
Pakistan and this paper also enlightened the solution how we can have a stable and moderate
inflation rate in the country this paper also discuss the ways which state bank can apply in order
to get a stable inflation rate in the country. This paper also discussed that during 1970-2009,
Pakistan had a inflation rate below 10% the massive increase in the inflation rate of Pakistan
after 2009 is mainly due to a massive increase in the interest rate of Pakistan.
Bangladesh is one of the most important member of the SAARC countries. It has been facing
similar economical issues as Pakistan is facing now-a-days .Increasing inflation rate is also one
of the most important issue in Bangladesh. Saif Ul Islam and Tasim Ud Din (2011) presented a
research paper on this major issue of increasing inflation rate in Bangladesh which elaborate that
the central bank of Bangladesh is not at all giving importance to the increasing inflation rate of
the country moreover they are not enforcing policies which help in making the inflation rate
stable and controlled. This research paper also discuss that Bangladesh monetary sector has
gained pretty much maturity and leading towards a good direction .this paper also elaborate that

Co-Integration In The Inflation Rates Of SAARC Countries

only interest rate can fight with the inflation rate and have a tendency to control it and make it
stable.
As it is discussed that inflation rate has impact on the Gdp and the economy of the country. If the
inflation rate is higher than the buying capability of the people than it has adverse effect on the
gdp and the economy of the country. Grijasanker and Chowdhury discussed this particular aspect
in their research paper that there is a significant impact of inflation rate on the Gdp and the
economy of the country. This research paper also discuss that there is a noteworthy relationship
in the inflation rate of the SAARC countries, this research paper restricted its research to four
SAARC countries (Bangladesh, Srilanka,India,Pakistan).this paper also indicate that moderate
inflation is beneficial for growth thus it is very important for SAARC countries to maintain a
good pace of economic growth so that they can have a balance in the inflation rate and the
economic growth of the country.

Co-Integration In The Inflation Rates Of SAARC Countries

Chapter 3: Research Methods

3.1 Sample Size:
30 Yearly observations of Inflation rates of SAARC countries.

3.2 Sources Of Information:

International Monetary Fund, www.imf.org

3.3 Variable To Be Studied:

Dependent variable: Inflation rates of SAARC Countries

3.4 Research Model Developed:

The multivariate Johenson co-integration test is applied to investigate the co-integration
of inflation rates of SAARC countries.

3.4.1 Statistical techniques: Johansen multivariate co-integration

Co-Integration In The Inflation Rates Of SAARC Countries

10

Chapter 4: Results
4.1 Findings and Interpretation of The Result:
The research is on the inflation rate of the SAARC countries and 30 yearly observations
of inflation rates were considered in the test of Johansen multivariate co-integration.
After the test the conclusions were that out of the seven SAARC countries, there is cointegration of inflation rates in between three of the SAARC countries namely;
Pakistan
India
Sri Lanka
The inflation rates of the other four SAARC countries are not co-integrated.

Co-Integration In The Inflation Rates Of SAARC Countries

11

Chapter 5: Conclusion & Future Research

5.1 Conclusion:
The conclusions were that out of the seven SAARC countries, there is co-integration of
inflation rates in between three of the SAARC countries namely;
Pakistan
India
Sri Lanka
The inflation rates of the other four SAARC countries are not co-integrated.

5.2 Future Research:

The further future research would come up as follows;
Factors responsible for co-integration in the inflation rate of three SAARC countries.
The factors because of which the other four countrys inflation rates are not co-integrated.

Co-Integration In The Inflation Rates Of SAARC Countries

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