Post on 16-Mar-2018
EXCHANGE RATE STABILITY AND IMPORT PENETRATION: THE CASE OF MALAYSIA AND
SINGAPORE
Tyson Teo Chih Soon
RG 3851 T314 Corporate Master in 2013 Business Administration
2013
Pusat Khidmat Maklumat Akadcmik Ul'.1VERSm MALAYSIA SARAWAK
EXCHANGE RATE STABILITY AND IMPORT PENETRATION: THE CASE OF MALAYSIA AND SINGAPORE
P.KHICMAT MAKL.UMAT AKACEMIK
11111 1lIllli'iiilll II II III 1000246851
TYSON TEO CHIH SOON
This project is submitted in partial fulfillment of the requirements for the degree of Corporate Master in Business Administration
Faculty of Economics and Business UNIVERSITI MALAYSIA SARAWAK
2013
STATEMENT OF ORIGINALITY
The work described in this Corporate Business Project, entitled "Exchange Rate Stability and Import Penetration: The Case of Malaysia
and Singapore" is to the best of the author's knowledge that of the author except
where due reference is made.
(Date Submitted) Tyson Teo Chih Soon 10031694
ABSTRACT
EXCHANGE RATE STABILITY AND IMPORT PENETRATION: THE
CASE OF MALAYSIA AND SINGAPORE
By
Tyson Teo Chih Soon
Q n this research, the relationship of nominal exchange rate stability and import
penetration between Malaysia (developing economy) and Singapore (developed
economy) are being examined. The time series data employed in this research consist
of annual data ranging from year 1980 to 2010. The methodology applied in this
research comprises of Augmented Dickey Fuller (ADF) unit root test, Johansen and
Juselius cointegration test as well as Granger causality test based on Vector Error
Correction Model (VECMY In the cases for both countries under review, the
Co integration test shows that there is an existence of long run equilibrium linkage
between both variables employed. Also, in short run, the Granger causality test
shows a positive bi-directional relationship from the independent variable (nominal
exchange rate stability) to dependent variable (import penetration ratio). Though the
relationship of both variables is similar between both countries, the degree of its
relationship varies.
ABSTRAK
KESTABILAN KADAR PERTUKARAN ASING DAN PENEMBUSAN
IMPORT: PENYELIDIKAN TERHADAP MALAYSIA DAN SINGAPORE
Oleh
Tyson Teo Chih Soon
Dalam kajian ini, hubungan antara kestabilan kadar pertukaran asing nominal dan
kadar penembusan import antara Malaysia (ekonomi sedang membangun) dan
Singapore (ekonomi maju) telah diambil kira. Kajian ini merangkumi tempoh masa
tahunan bermula dari tahun 1980 sehingga 2010. Kaedah-kaedah yang telah
diaplikasikan dalam kaj ian ini terdiri daripada 'Augmented Dickey Fuller (ADF) unit
root test', ujian pengamiran 'Johansen and Juselius' dan juga ujian penyebab
(Granger causality) berdasarkan ujian 'Vector Error Correction Model' (VECM).
Dalam keputusan ujian ke atas data kedua-dua negara yang dikaji, ujian pengamiran
menunjukkan terdapat hubungan keseimbangan dalam jangka panjang antara
pembolehubah-pembofehubah yang diaplikasikan. Juga, dalam jangka pendek, ujian
penyebab 'Granger causality' menunjukkan terdapat hubungan positif satu hala dari
pembolehubah tidak bersandar (kestabilan kadar pertukaran asing nominal) kepada
pembolehubah bersandar (kadar penembusan import). Sehubungan itu, keputusan
ujian yang dijalankan menunjukkan hubungan positif dari pembolehubah tidak
bersandar terhadap pembolehubah bersandar dalam jangka pendek. Walaupun
hubungan antara kedua-dua pembolehubah yang diaplikasikan an tara kedua-dua
negara adalah samar, akan tetapi, tahap kesannya adalah berlainan. \
ACKNOWLEDGEMENT
It would not have been possible for me to complete this study without the
helps from the faculty, family members and friends. Therefore, I would like to
express my gratitude to these individuals for their encouragement, guidance and
support.
I am indebted to my Supervisor, Dr. Evan Lau. He has made available his
support in a number of ways to further enrich my academic life. In reviewing my
study, he is indeed fair reviewer. Along with painstaking comments, he did not
hesitate to give compliments in some parts of my work. What has encouraged me the
most is that he always demonstrates his faith in my ability to complete my work.
Last but not least, thanks to all my seniors and my friends who had directly or
indirectly given their hands in completing my final year project, especially for Thien
Fung Thai and Tan Chiang Ching. Moreover, I would like to express my sincere
"thank you" to my family members. This study could not be successful completed
without your mental and physical support.
Thank you so much to you all! Simply saying "thank you" would never be
sufficient to actually express my heartfelt thankfulness.
- - - - - ~--- --------pusat Khidmat Maklumat Akadtmik UNlVERSm MALAYSIA SARAWAK
T ABLE OF CONTENTS
LIST OF TABLES
PAGE
x
LIST OF FIGURES x
CHAPTER ONE: INTRODUCTION
1.1 Introduction ..................... ..... ................ .. .. .. .... ............ .. .......................... .
1.2 Concept of Study. . . . . . . . . . . . . . . . . . . . ... .............. .......... ........ .. .......... ........... 3
1.3 Malaysia's Nominal Exchange Rate Stability (MNERS)...... .................. 4
1.4 Malaysia Import Penetration Ration (MIPR)...................... .... ................. 6
1.5 Singapore's Nominal Exchange Rate Stability (SNERS) .... ............. 7
1.6 Singapore Import Penetration Ratio (SIPR) .. ............................... 9
1.7 Problem Statement............. .. .................. ... . .. ..... .. ... .... ........ 10
1.8 Objectives of the Study............ .... ....... .... ........... ...... .. ................. .... ........ 12
1.8.1 General Objective ......... .... ........................... ...... ... .......... ...... ......... 12
1.8.2 Specific Objectives........ .. ....... .... ..................... .. ............................. 12
1.9 Significance of the Study............................................... .. ....................... 13
1.10 Structure of Study . . .................. ....... .. .... ................................................. 14
vii
CHAPTER TWO: LITERATURE REVIEW
2.1 Introduction... ..................... .............. .............................. ............ ............. 15
2.1 Reviews on Previous Study...................................................................... 15
CHAPTER THREE: METHODOLOGY
3.1 Introduction ............................................................................................. 26
3.2 Concept ofYariables ............................................................................... 26
3.2.1 Exchange Rate Stability (ERS) ...................................................... 26
3.2.2 Import Penetration Ratio (lPR) ...................................................... 27
3.3 Data Description................................................................ 28
3.4 Augmented Dickey-Fuller (ADF) Test ................................................... 28
3.5 Johansen and Juselius Cointegration Test........ .................................... 30
3.6 Granger Causality Test........ ................................................................. 31
CHAPTER FOUR: EMPIRICAL RESULTS AND DISCUSSIONS
4.1 .Introduction ....... ....................... ................................... ............. ............... 34
CHAPTER FIVE: CONCLUSION AND RECOMMENDATIONS
5.1 Introduction .................................................................................... :........ 38
viii
5.2 Summary of Findings ............ .... ........ ....... ............. .......... .. ....... ..... ......... .. 39
5.3 Policy Implications ...... .... .................. ....... .................... .. ..... .. ................. 41
5.3 Limitation of Study .......................................................... ....................... 42
REFERENCES 43
ix
LIST OF TABLES
PAGE
Table 2.1: Review of Literatures .......... ....... ...................... .. .......... .. ............ ...... . 22
Table 4.1 (a): Augmented Dickey-Fuller (ADF) Unit Root Test Results
Table 4.1 (b): Augmented Dickey-Fuller (ADF) Unit Root Test Results
(Malaysia) ............................. .. ...... .... ... ................. .. ........ ............... 35
(Singapore) ............ ...... .............. ............... ... ........... ....... ................ 35
Table 4.2(a): Cointegration Test and Hypothesis Testing (Malaysia) ................ 36
Table 4.2(b): Cointegration Test and Hypothesis Testing (Singapore) .............. 36
Table 4.3(a): Granger causality Test in VECM Results (Malaysia) ................... 37
Table 4.3(b): Granger causality Test in VECM Results (Singapore) ................. 37
LIST OF FIGURES
PAGE
Figure 1.1: Malaysia's Nominal Exchange Rate Stability from 1980 to 2010 ................. .. ........................ .... .............. .... ........... ....................... 4
Figure 1.2: Malaysia's Import Penetration Ration from 1980 to 2010 ....... ................... ... ........ ............ ..... ............................................. 6
Figure 1.3: Singapore's Nominal Exchange Rate Stability from 1980 to 2010 ........................................................................... 7
, Figure 1.4: Singapore Import Penetration Ratio from 1980 to 2010 .................. 9
x
CHAPTER 1
INTRODUCTION
1.1 Introduction
The study of stability within exchange rate has spawned various economics
concern and views pertaining inflationary level, investment fields, asset management,
political concerns and many more. In terms of sensitivity, the stability within the
value of any currency posses' directs impact on the currency exchange rate. This is
because exchange rates express the value of one country's currency in relation to the
value of another country's currency (Carbaugh, 2008). Hence, stability of the
currency value is of paramount in macro-policy or more specifically, the monetary
conduct of an economy.
The exchange rate stabilization policy plays an important part in not only the
economy's monetary performance, but also various considerations within an
economy. These considerations might range from investment strategies to domestic
demand patterns and so on. The relationship between exchange rate and international
trade has been reviewed on numerous writings before. However, the measurement of
the stability in exchange rate has 'been done on different gauging bases. Few
examples can be seen by literature provided by Aizenman et al. (2009) and Calvo
and Reinhart (2002).1
1 Aizenman el al.(2009) compares the currency's exchange value monthly standard deviation against a base country in his model whilst Calvo and Reinhart (2002) took into account of the percentage changes in foreign reserves and the absolute changes in nominal interest rates.
The exchange rate for emerging or developing countries is vulnerable to
external factors for most of the time. For example, the Asian financial crisis has
cause the Ringgit to lose its value at a devastating rate. The reason behind this event
was due to the sudden and enormous capital flight where foreign investors lost
confidence towards Malaysia financial market. Also, the trade sector was not in
favourable situation jUdging from both importation and exportation side of the
industry due to the competitiveness issue. As uncertainty and volatility in currency
exchange reduces the prospect of long run trade agreement, trade activity was being
done mostly by spot-on price and it impairs very much on purchasing power
capability by the locals.
On the other hand, as trade issues have long being associated with the
volatility of exchange rate. Moreover, much of the empirical research has placed
emphasis on usual variables such as trade balance (import and export). In deviation
from most conventional research, this research emphasises on the relationship of
exchange rate stability and import penetration ratio. Such researches are being
performed on numerous occasions, however, their empirical evidence from were far
from collectively unanimous. For example, Trefler (1993) suggest that the effect of
import penetration ratio were not significant, whereas, Finger and Harrison (1994)
and Lee and Swagel (1996) claimed that protectism on local industries from foreign
competition were particularly higher on countries with a higher degree of import
penetration ratio. In addition, Goldberg and Maggi (1996) proposed that the effect
from this ratio on trade protection policy for the political clustered sectors
(government-linked sectors) is negative, but not statistically significant (Maggi and
Andres, 1998).
2
1.2 Concept of Study
Trade is one of the main propellants for a country's economic growth and
eventually its development status. However, only the import component will be taken
into consideration within this study. The direction of the fluctuation for the exchange
rate variable will also have to be taken into consideration in detennining the
relationship between the stability of the exchange rate and import penetration as well.
As fluctuation within the exchange rate variable will theoretically encourage or
discourage domestic demand on foreign goods and services, the direction of the
exchange fluctuation needs to be monitored as well. Given a scenario, a favorable
exchange fluctuation on the home country (i .e., relatively stronger home currency)
increases the purchasing power parity of home country and thus, enabling higher
degree of import penetration on domestic market and vice versa.
An example of such scenario would be the case of China's economy in the
manipulation of its exchange rate by artificially keeping its value low relatively with
its trading partners. This is being done to gain upper hands in view of their
international trade, as being mentioned on previous paragraph. Furthermore, the
Japanese and Brazillian monetary authority has also taken similar measures to
support their trading industries (Sanger and Wines, 20 I 0).
All in, the activity mentioned above engages very much on exchange rates
variable and its stability will impact upon purchasing decision of domestic market for
goods and services from abroad. Hence, this research examines the relationship
between exchange rate stability and import penetration ratio of the economy under
review. In other words, the research takes into consideration the sensitivity of
exchange rate variable and total import values which satisfy domestic demands.
3
1.3 Malaysia's Nominal Exchange Rate Stability (MNERS)
Figure 1.1 Malaysia's Nominal Exchange Rate Stability from 1980 to 2010
3
2
1
~ ~
0
0 -1 :;::; ro a:: -2
-3
-4
-5 1980 1985 1990 1995 2000 2005 2010
Year
1- MNERS 1
Source: InternationaJ Finance Statistics, International Monetary Fund, Various Issues
Figure 1.1 shows the trend of the stability within MNERS from year 1980 to
2010. The stability in the nominal exchange rate is fairly volatile throughout 1980 to
2010. However, such volatility was heightened in the event world economic crisis for
example during the early 1980 and mid 1990.
In the early of 1980, the trend experienced significant instability due to the
effect of global oil shock (see Hamilton, 2011). On the other hand, the period of mid
90s, specifically during the 1997 Asian Financial Crisis highlights a direr drop of
NEER and hence, reflecting higher instability in the trend. However, it starts to peak
up due to the stabilization policy implemented by the Central Bank to counter off
financial speculation activities or commonly being referred to as "currency attack",
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Pusat Khidmat Maklumat Akademik UNIVERSm MALAYSIA SARAWAK
which was the major cause of the crisis at that time2 • From that point onwards, the
trend of the stability in NEER are relatively more stable than it was before except
during early 2010 where the economy felt a brush of the dot-com bubbles3 (which
caused minor volatility ofNEER) which originated from the western economies.
1 Refer to International Monetary Fund (1997a) 3 Refer to Goh and Lim (2010)
5
1.4 Malaysia Import Penetration Ratio (MIPR)
Figure 1.2 Malaysia's Import Penetration Ratio from 1980 to 2010
4.8 ·
4.4
~ ~ 0
~ a::
4.0
3.6
3 .2
2.8 1980 1985 1990 1995 2000
Year
I-MIPRI
2005 2010
Source: International Finance Statistics, International Monetary Fund, Various Issues
Figure 1.2 shows the trend of the MIPR from year 1980 to 2010. The trends
are quite stable with respect to some minor instability throughout the period.
Nevertheless, the volatility was clearly highlighted during the second quarter of 1980.
This trend might well be the result of economic structural reforms from a heavy
agrarian-based economy to manufacturing economy (see Tang and Haji Alias, 2000).
Furthermore, the Malaysia's economy is moving from a more agrarians based
economy to manufacturing based economy with export orientation (Tang and Wong,
2007). In a more recent scenario, the economic structure has been transformed into a
more service based economy (knowledge, tourism and servicing) 4 and this shows a
differentiated reliance (significantly lower ratio) on importing needs from the period
of 1990 onwards.
~ Refer to Mahadevan (2007) on the transition of Malaysia economic structure and also on Economic Transformation Programme.
6
1.5 Singapore's Nominal Exchange Rate Stability (SNERS)
Figure 1.3 Singapore's Nominal Exchange Rate Stability from 1980 to 2010
2.0
1.5
1.0 ~
:oR ~ 0.50
15 Q::
0.0
-0.5
-1.0 1980 1985 1990 1995 2000 2005 2010
Year
1- SNERS III
Source: International Finance Statistics, International Monetary Fund, Various Issues
Figure 1.3 shows the trend of the stability within SNERS from year 1980 to
2010. The stability in the nominal exchange rate is volatile throughout the timeline
and was heightened especially during the event world economic crisis for example
throughout 1980.
Throughout 1980, the stabi 'lity in SNERS experienced significant instability
due to the effect of global oil shock, much like the effect felt by its neighbouring
Malaysia (see Hamilton, 2011). On the other hand, the economy felt much lesser
effect from the infamous 1997 Asian Financial Crisis though the trend records a
decline of NEER. Such attribute are the results of different monetary conduct of the
Monetary Authority of Singapore. Though the crisis affected the Asian region,
ingapore was particularly cushioned from the effect relatively due to its stronger
fundamental in Monetary Authority of Singapore's monetary practices.
7
Since 1981, the Monetary Authority of Singapore has been practicing a more
disciplined monetary conduct where it is managed float against a basket of currency
(which would have seen much impact if compared to free float exchange regime). On
top of that, their exchange rate policy band is periodically reviewed to ensure that it
remains consistent with underlying fundamentals of the economy. This measure is
the crucial element in systematically assessing the path of the exchange rate in order
to avoid a misalignment in the currency value (Monetary Authority of Singapore,
2012).
8
1.6 Singapore Import Penetration Ratio (SIPR)
Figure 1.4 Singapore lmport Penetration Ratio from 1980 to 2010
5.4
5 .3
5 .2
~ 0- 5 . 1 0 :p co
cr:: 5.0
4.9
4.8
4.7 1980 1985 1990 1995 2000 2005 2010
Year
I-SIPRI
Source: International Finance Statistics, International Monetary Fund, Various Issues
Figure 1.4 shows the trend of the SIPR from year 1980 to 20 10. The trend
shows a more volatile pattern throughout the period compared to Malaysia's case.
However, the period of post millennium records a higher penetration ratio from prior
to it.
All in, the relatively volatile trend might be attributed to trade dependence
(openness) characteristic which the economy posses. However, this does not
necessarily represent true import penetration, but rather the presence of re-exports in
the raw data. This is because Singapore is the type of open economy which revolves
around entrepot activity (importing for exporting purposes) since the dawn of its
existence.
9
1.7 Problem Statement
An exchange rate movement is usually indicator for an economy's
competitiveness judging from the argument from finance to international trade. In
such case, the developing and developed economy like Malaysia and Singapore5 are
relatively sensitive to externality such as exchange uncertainty, which is very much
attributed to their small-open economies.
Though higher degree of stability in exchange movement are being
maintained mainly for the purpose of deterring speculation practices by foreign
investors, especially within the field of finance and investment, it can also iiJustrate
higher degree of trade protectionism policy. As the import penetration issue of a
country is concerned, the self-sustaining issue will not be far behind. A higher degree
of penetration ratio might suggest that a country under review has higher dependency
on importations and this might raise an alarm in some areas on national security (i .e.,
excessive dependency on foreign agricultural products or food products). According
to the MIPR and SIPR (refer to figure 1.2 and 1.4, respectively), the trends are
generally showing lesser penetration ratio that of Malaysia's side compared
Singapore. This brings about the question of viability of sustainabi lity in country's
overall production to satisfy its own domestic demand where is it more prone to the
development of economic status (i.e., developing or developed) or is it weighing
more on the factors of abundance as being illustrated by Heckscher-Olin Model.
Whenever a discussion or study are being performed on variables concerning
exchange rate (in this case, exchange rate stability), the discussion on its impact on
S Classifications are based on information obtained from World Bank (Country and Lending Group) where the Malaysia is categorized under developing economy whilst Singapore is under high income (developed) economy.
10
international trade will not be far behind. The degree of stability in the exchange rate
is correlated to various components within a country's economy. Cases in point,
transaction involving foreign exchange are very much linked to a country's business
activity (especially those involved in import and export industry), gross domestic
product and also the rate of employment. Theoretically, the public will spend less on
goods and services not only from domestic supplier, but from foreign supplier
(import) as well. When this happens, the central banks will interfere to manipulate
their currency's value to their economy's advantage and this are being portrayed by
the degree of stability on its exchange rate.
Furthermore, a more stable exchange rate movement are deemed to be more
favourable to international trading prospect. However, it is this conclusion is far from
evidently conclusive as Malaysia is adopting a more stabilized exchange regime for
more than a decade now and Singapore has been opting for a freer exchange regime.
In all, these two countries might pose different monetary conduct but relatively
similar economic size attributes.
In a nutshell, the viability of exchange stabilization policy practiced by
Malaysia after the infamous 1997 Asian financial crisis is yet to be determined in
handJ ing future financial crisis, as applied to Singapore's monetary conduct too. The
effect of such variable might directly or indirectly impact upon the patterns of
domestic demand for these two economies as well.
11
1.8 Objective of Study
The short run and long run relationship between the nominal exchange rate
stability (MNERS and SNERS) and import penetration ratio (MIPR and S[PR) for
Malaysia and Singapore are yet to be determined. Furthermore, the determinant of
causal relationship between these two variables within these two economies is also
yet to be answered. With this, the objectives to investigate this matter are as follow:
1.8.1 General Objective
• To examine the relationship between exchange rate stability and import
penetration ratio for both Malaysia and Singapore for the period according to
each country's data availability.
1.8.2 Specific Objectives
• To examine the long run relationship between exchange rate stability and the
level of import penetration ratio in Malaysia and Singapore.
• To detennine the short run causality between exchange rate stability and level
of import penetration ratio in Malaysia and Singapore.
12
1.9 Significance of Study
In pursuing higher level of economic status, a country's governing authority
would have to achieve such goal starting from a tactical basis and in this case,
regulating the microeconomic environment via various microeconomic policies. For
instance, formulation of microeconomic (short term) policies must also have in sight
ofa country's macroeconomic (long term) policies. For these two policies to function
in a synergy condition, a study on an economy's microfoundation (for example,
domestic demand pattern) will help in forecasting the needs of future monetary
conduct (macroeconomic policy) of the country.
When a country has achieved or is in the standard of a developed economy,
its next goal is to formulate and execute a long term stabilization policy. This would
then highlight the needs to devise various strategic economic growth policies to
sustain the economic advancement. In such economic phase, an economy relatively
possesses a higher degree of openness (and thus, more liberated exchange regime)
compared to those of a developing economy. In these arguments, the stability of
exchange rate variable plays a significant role in determining the country's long term
capability in regulating its international trade.
This research can be significant in the sense that its findings can provide
important insights and thus, implication on the formulation of not only
macroeconomics policy, but microeconomic policy as well. To pinpoint this claim,
the policymakers can formulate a more effective monetary conduct to gauge
exchange sensitivity whilst addressing domestic consumption demand.
Besides that, a study on the pattern of domestic consumptions which are
being satisfied by products abroad can also be utilized for various indication
13
purposes such as an insight of a country' s purchasing capability, degree of trade
protectionism policy, economic growth direction and so forth. A higher degree of
such consumption suggest that a country's domestic reliance on imports are
significant and thus, gives an idea of the how the trade balance are going to perform
while a lower degree would suggests otherwise. With such measurement, the
fonnulation of various micro and macro level economic policies can be done on a
more effective and surgical basis.
1.10 Structure of Study
The following chapter focus on the review of previous studies, Chapter 3
discuss on the methodology to be applied in this research followed by Chapter 4
focusing on the results and discussion. The last chapter concludes this research with
pol icy implications.
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