Adnan , Uzma & Butt

Relationship between Exchange Rate, Exports and Imports: Analysis in the form of Co- integration and Bi-Variate

Causality. Empirical Evidence from Pakistan.

Qazi Muhammad Adnan Hye

Uzma Iram

&

Muhammad. S. Butt

4th International Conference on

Statistical Sciences

Adnan , Uzma & Butt

1.0INTRODUCTION:

• The present endeavor readdressed currently debated issue, on the relationship between exchange rate, exports, and imports for a developing economy like Pakistan. Relevant literature has observed the substantial but contradictory evidence about the impact of exchange rate volatility on international trade.

• Those support the hypothesis that volatility of the exchange rate is negatively related with the volume of trade are included Ethier (1973), Hooper and Kohlhagen (1978), Akhtar and Hilton (1984); Cushman (1983, 1986, 1988); Kenen and Rodrick (1986); Pere and Steinherr (1986); Thursby and Thursby (1987); De Grauwe (1988); Koray and Lastrapes (1989); and Arize (1995) Kumar and Dhawan (1991), Broll (1994), Caporale and Dorodioon (1994), Wolf (1995), Dell’Ariccia (1998), Rose (2000), and Vergil (2002) .

Adnan , Uzma & Butt

INTRODUCTION:

• Whereas some studies found inconclusive impact of exchange rate volatility on export’s growth for developing countries as they have explained variation in exchange rate policies and the level of growth [Bahmani-Oskooee (1984, 1986); and Rana (1983)].

• Such evidence further support the view that there is an ambiguity in the role of exchange rate volatility on trade volume.Bahmani-Oskooee (1984,1986) found that exchange rate has a significant impact on trade flows of selected developing countries even in periods when most of them had pegged exchange rates.

Adnan , Uzma & Butt

• For Pakistan impact of exchange rate volatility on the volume of trade has been studied since the late 1970’s when the exchange rate moved from fixed to flexible exchange regime. That high degree of volatility and uncertainty of exchange rate movements since the beginning of the generalized floating in 1973 have led policy makers and researchers to investigate the nature and extent of the impact of such movements on the volume of trade.

• But a few empirical studies are available in the context of Pakistan. Kumar and Dhawan (1991) estimated the exchange rate volatility on Pakistan exports to the developed world from 1974 to 1985. They found that, volatility of exchange rate adversely effect on export demand

1.0 INTRODUCTION:

Adnan , Uzma & Butt

• Khalid and Nishat(2004) investigated the behaviour of exchange rate volatility on exports growth and found that, the volatility of exchange rate has negative and significant effects both in the long run and short run with major trade partners namely UK and US. Similar pattern was observed in case of Australia, Bangladesh, and Singapore, where the volume of trade with Pakistan is comparatively consistent and less volatile. The relationship between exports growth and exchange rate volatility for India and Pakistan is observed only in long run perspective.

1.0 INTRODUCTION:

Adnan , Uzma & Butt

Aim of the Paper

The present study has focused on the relationship between exchange rate, exports, and imports rather than the effect of exchange rate. The aim of this study to explores the direction of causality between exchange rate, exports, and imports by employing relatively most recent robust techniques .

Data and methodology:

The empirical analysis is based on Monthly time series data from 1995 - 2006.The data of X (Exports), M (Imports) and ER (Nominal Exchange rate index) used in this study is taken from the International Financial Statistics (IFS). Exports and Imports are measured in million of rupees at current prices.

Adnan , Uzma & Butt

Econometric Methodology:

ADF Test PP Test JJ-C0-integration Test VEC Variance Decomposition Analysis Standard Granger Causality Test Error Correction Based Granger Causality Test

Adnan , Uzma & Butt

Result of Unit Root

Table-1 ADF AND PP UNIT ROOT TESTS

( 1995 - 2006 )

Variable Augment Dickey Fuller Test Phillips-Perron Test

Level 1st Difference Level 1st Difference

X -0.2096(4) -8.21(4) -0.5344( 3) -26.8 (3)

M 0.862 (3) -6.93 (3) 1.582(4) -7.299(4)

ER -2.179 (1) -8.626 (1) -2.294 (4) -9.514 (4)

NoteX = ExportsM = ImportsER = Exchange rate(a) The Mackinnon critical values for ADF and PP test statistics are -3.48, -2.89 and -2.58 at 1,5 and 10 percent level of significance, respectively.(b) Figures in square bracket are the number of lags.(c) Lag length selected through Schwartz Criterion

Adnan , Uzma & Butt

Co-integration Result: Table-2:Johansen Maximum Likelihood Test for Co-integration

Max-Eigen Statistic

Null Hypothesis AlternativeHypothesis

Max-Eigen Statistic

5 % critical value

Prob.

r =0 r =1 27.62745* 21.13162 0.0109

r 1 r=2 7.534393 14.26460 0.5162

r ≤ 2 r=3 0.002088 3.841466 0.9600

Trace statistic test

Null Hypothesis

Alternative Hypothesis

Trace -statistic

5 % critical value

Prob.

r =0 r ≥ 1 35.16393* 29.79707 0.0053

r≤ 1 r ≥ 2 7.536480 15.49471 0.4280

r ≤ 2 r ≥ 3 0.002088 3.841466 0.9600

Note: *: Significant at the 5% level. Lag length selected through Schwartz Criterion

Adnan , Uzma & Butt

VEC

Table-3:Result of Vector Error Correction

D(X) D(M) D(ER)

Adj.coefficient -0.573216 -0.178772 -5.27E-06

Standard Dev.  (0.11939)  (0.16321)  (4.1E-05)

t-statistic -4.80114* -1.09536 -0.12804

Note: * : Significant at 1%

Adnan , Uzma & Butt

Variance Decomposition AnalysisTable-4:

Results of Variance Decomposition

Variance Decomposition of X:

Period X M ER

1 100.0000 0.000000 0.000000

2 93.47143 5.719588 0.808986

3 84.57524 13.40185 2.022909

4 76.58780 20.16888 3.243320

5 70.15934 25.48310 4.357564

6 65.08916 29.54942 5.361415

7 61.05601 32.66923 6.274768

8 57.79322 35.08917 7.117612

9 55.10570 36.98893 7.905378

10 52.85464 38.49618 8.649177

Adnan , Uzma & Butt

Variance Decomposition of M:

Period X M ER

1 43.10378 56.89622 0.000000

2 35.32174 64.54693 0.131332

3 30.86398 68.81713 0.318881

4 28.14384 71.32868 0.527475

5 26.37641 72.87371 0.749880

6 25.16244 73.85236 0.985198

7 24.28799 74.47850 1.233505

8 23.63221 74.87313 1.494660

9 23.12338 75.10846 1.768157

10 22.71700 75.22981 2.053192

Variance Decomposition Analysis Adnan,Uzma & Butt

Adnan , Uzma & Butt

Variance Decomposition of ER:

Period X M ER

1 1.831917 0.006873 98.16121

2 1.817773 0.063739 98.11849

3 1.852644 0.148774 97.99858

4 1.913900 0.255325 97.83078

5 1.990017 0.379969 97.63001

6 2.074703 0.520331 97.40497

7 2.164320 0.674414 97.16127

8 2.256654 0.840399 96.90295

9 2.350290 1.016590 96.63312

10 2.444278 1.201409 96.35431

Variance Decomposition Analysis Adnan,Uzma & Butt

Adnan , Uzma & Butt

Impulse Response Function

Adnan , Uzma & Butt

Table-5

Table-5Granger-Causality Test

Direction of causality F-Statistic Probability

M → X 3.44441* 0.00136

X → M 2.26573* 0.02743

ER → X 0.50424 0.85104

X → ER 0.56798 0.80227

ER → M 0.70112 0.68997

M → ER 0.43608 0.89722

Inference : X →M M →X Bivariate causality between Export and ImportsNote: → shows the direction of causality

Adnan , Uzma & Butt

Table-6Bi-variate Engle Granger-Causality Based Error correction models Result.

S.NO Equation F-Statistics

D(X)

F-Statistics

D(M)

F-Statistics

D(ER)

ECt-1 R2 DW

1 X=f(M) 42.38* - - -0.218* 0.55 2.15

2 M=f(X) - 45.22* - -0.088** 0.53 2.19

3 X=f(ER) 1.57 - - -0.127 0.27 2.29

4 ER=f(X) - - 1.97 -0.03 0.11 1.92

5 M=f(ER) - 0.883 - -0.018 0.22 2.32

6 ER=f(M) - - 1.05 -0.031 0.11 1.92

Note: *: ** Significant at 1 and 5% respectively.Inference : X →M M →X Bivariate causality between Export and Imports

Adnan , Uzma & Butt

4.0 CONCLUSION AND POLICY IMPLICATIONS:

The present study investigates the query to direction of causality between exchange rate, exports and imports, using Pakistan monthly time series data for 1995.-2006 periods. The results indicate that exports (X) are co integrated with imports (M).

It is thought that negative trade balance can be reversed in the long-run by increasing exports if imported goods bring new technology and a different entrepreneur skill to home country. Therefore, exports and imports are co integrated.

This result is supported by co integration test results (Johansen co integration test has concluded that there is exactly one co integrated vector). Also the variance decomposition result presented relationship between exports and imports since a shock to exports or imports can be explained by exports and imports. There is bi-directional causality has been found between Exports and imports.

Adnan , Uzma & Butt

Another result from this empirical investigation is that there is no relationship between exchange rate and trade at current prices. The variance decomposition test states that the power of exchange rate to explain the change in exports and imports is 8.65% and 2.054% respectively after 9-year period . When there is a shock to exchange rate innovations than Exchange rate accounts for the change in itself only.

4th International Conference on

Statistical Sciences