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Procedia - Social and Behavioral Sciences 58 ( 2012 ) 1293 – 1300

1877-0428 © 2012 Published by Elsevier Ltd. Selection and/or peer-review under responsibility of the 8th International Strategic Management Conference doi: 10.1016/j.sbspro.2012.09.1112

8

th

International Strategic Management Conference

Relationship between Real Oil Price and Real Exchange Rate:

the case of Turkey

a b

, Selim Demez

c

a*

a,b,c

Abstract

For developing countries like Turkey which lack of sufficient amount of oil and energy resources, real exchange rate and real oil prices are important for sustainable economic growth rate. The academic accounts focusing on the fluctuation in both factors in the oil exporting and developed countries also show that real oil prices are influential in determining the real exchange rates. There are only a few works on the developing countries. In the non-oil exporting-developing countries, real oil price is affected by the fluctuations in the real exchange rate which require changes to the macro-economic policies. This paper investigates the long-run relationship between real oil prices and real exchange rates by using a monthly data from 02:2001 to 07:2011. In the work, cointegration with structural breaks tests by Perron veKejriwal (2009) are used.

Keywords:Real exchage rate, Real oil price, Turkey

2 Published by Elsevier Ltd.Selection and/or peer-review under responsibility of The 8th International Strategic Management Conference

1.Introduction

A number of developing countries including Turkey rely on export-oriented development model for economic growth . The ability of these countries to be competitive in international markets depends on their ability to preserve their competitiveness in global markets in respect to the production costs, particularly in industrial products by minimizing the costs

* Corresponding author: Tel.: +90-530-348-0908 E-mail address: ustaoglu@istanbul.edu.tr

© 2012 Published by Elsevier Ltd. Selection and/or peer-review under responsibility of the 8th International Strategic Management Conference Open access under CC BY-NC-ND license.

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. The elements and factors that determine the real exchange rate and energy costs include real oil prices, which allow these countries to make estimations on the cost calculations of the exporter firms and future production plans(Vincent & Bertrand, 2011). Energy costs and currency exchange policies influence the foreign trade volume of the developing countries; they hold primacy and importance in the macroeconomic indicators of the developing countries through the volatility in oil prices. The fluctuations in oil prices since 2000s and the global financial crisis in 2007 led to negative growth rates in a number of developed countries; this also led to the bankrupt of some EU countries and to some ongoing economic problems as well. On the other hand, Far East and Asian countries were least affected by these crises because of their reliance on export-oriented development model. Despite problems of current deficit, foreign trade deficit and unemployment, Turkey has been less affected by the global economic crisis owing to the economic stability program implemented since 2000s. The financial stability program implemented to address the crises in 2000 and 2001 helped the policy makers to regulate the financial markets in Turkey and created a strong and sound financial system; owing to this, Turkey has been less influenced by the global financial crisis that strongly affected the EU and US. Despite all these positive developments, real oil price and real exchange rate fluctuations put strong pressure upon the economy and negatively affect the foreign trade corporations. For this reason, real exchage rates and real oil prices are two important factors for domestic economies especially for developing countries. This paper investigates the long-run relationship between real oil prices and real exchange rates by using a monthly data from 02:2001 to 07:2011 by utilization of cointegration with structural breaks tests of Perron andKejriwal(Kejriwal, 2009; Perron, 1989).

2.Literature Review

Literature features some accounts focusing on the linkage between real exchange rate and real oil prices. Open market developing economies directly influenced from exchange rate and real oil prices fluctuation(Rodrik, 1999).Clarida and Gali (1994), Chen and Chen (2007), Yousefi and Wirjanto (2004), Camarero and Tamarit (2002), focusing on OPEC countries and developed countries, they find that the real oil price is the one of the most important factor determining real exchange rates in the long run for specifically developed countries(Clarida & Gali, 1994; Chen & Chen, 2007; Yousefi & Wirjanto, 2004; Camarer & Tamarit, 2002).Also,Krugman (1983), McGuirk (1983) veRogoff (1991),in their work volatility(Krugman, 1983; McGuirk, 1983; Arize, Osang, & Slottje, 2000; Nikbakht, 2000).

Relationship between exchange rate volatility and foreign trade volume in developed countries show that this could have impacts upon foreign trade volume whereas some other studies conclude that this has limited impact for the developing countries(Vincent & Bertrand, 2011; Arize, Osang, & Slottje, 2000; McKenzie & Brooks, 1997).Chen and Chen (2007) investigated the long-run relationship between real oil prices and real exchange rates by using a monthly panel collected from G7 countries in the long run(Chen & Chen, 2007; Nikbakht, 2000). They discoveredthe real oil prices might be the dominant factor of real exchange rate movements. And, there is a link between real oil prices and real exchange rates. In conclusion, they pointedthat panel predictive regression estimates suggest that real oil prices might have forecasting power(Chen & Chen, 2007; Nikbakht, 2000).

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3.Methodology and Data Collection

3.1.Research Goal

This study investigates the impact of real oil prices fluctuation on real exchange rate in the long run for Turkey by utilizing the relevant series of effective currency rate as well as monthly real oil prices between 02: 2001 and 07: 2011.

3.2. Sample Data Collection

The relevant series of real exchange rate and real oil price data for the period of 02:2001 and 07:2011 were collected from the International Financial Statistics (IFS), regularly published by the International Monetary Fund (IMF)(IMF, 2012; IFS, 2012).Because of the oil prices are set on the US dollar currency, the effective currency exchange rate for the US dollar was preferred.The data retrieved from IFS was deflared by real exchange rate nominal exchange rate CPI; the nominal prices in US currency were converted into the national oil prices to make them real prices through purification from price fluctuations by CPI. Monthly series between 02: 2001 and 07: 2011 were used to analyze for the period where fluctuated currency exchange system was implemented.Data series were made more linear by taking the natural logarithm.The tests were performed by Gauss 10.0 and Eviews 6.0 software.

3.3 ADF Unit Root Test

In this test, also know as Augmented DF testi (ADF) in the literature, it is possible to test the model in a higher autoregressive process by addition of dependent variables as observed below:

Yt= Yt-1+ p i t-i+1 i=2 + t (1) Yt=c+ Yt-1+ p i t-i+1 i=2 + t (2) Yt= c+ Yt-1+ t+ p i t-i+1 i=2 + t (3)

Ytrepresents dependent variable, c fixed term, t trend in trend model. As seen in the models, the lag length of the dependent variable areadded to the model. It differs from the DF test in this respect.

Equation (1) represents trend-less and fixed term-less model, Equation (2) the model with fixed term and

Equation (3) both trend and trendless model. For this test;

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H0=Unit root available; series not stable

H1=No unit root; series stable. The rejection of null hypothesis shows that the series does not hold unit root and that it is stable.

3.4. ADF Unit Root Test Result

Tablo 1 ADF Unit Test Results

*The values in parantheses refer to the lag lengths criteria based on the SIC criterion.

** The values in the bracketed parantheses are MacKinnon (1996) critical values in the 5% significant level for ADF test.

The Table shows that the results of the ADF unit root test proves that the real exchange rates (RER) and real oil prices (ROP) series are not stable at level values but they are stable in the first difference [I(1)].

3.5. Kejriwal Methodology

Zivot Andrews (1992), Lee-Strazicich (2003), Lumsdaine and Papell (1997) coined unit root tests that consider single and double breaks(Andrews, Donald, & Andrews, 1992; Lee & Strazicich, 2003; Lumsdaine & Papel, 1997). These tests were developed against the external and single breaks Perron(1989); but they were criticized because it restricts the number of breaks(Perron, 1989). It is possible to talk about more than structural breaks for a period. Bai-Perron (1989), Kapetonios (2002) observed that the break unit root tests create stronger results(Bai & Peron, 1998; Kapetanios, 2002). Hatemi-J (2008), by reliance on two-regime co-integration test, tested two long term structural breaks(Hatemi-J, 2008). But in this test, number of breaks was restricted.Kejriwal-Perron (2009) shows T

sample size under m structural breaks(Ketenci, 2012):

' '

t j bt bj ft f t

y

c

z

x

u

(

t T

j 1

1,..., )

T

j

(4)

For

j 1,...m 1while j=1

T

0

, m+1 is presented as

T

m 1

T

is expressed as

y

t represents independent variable,

x

ft

(

p

f

1)

ve

X

bt

(

p

b

1)

[I(0)] variables at stable level

and

z

ft

(

qf

1)

and

Z

bt

(

q

b

1)

represent [I(1)] variables.The scaler in the model

y

tvariable is first

degree stable[I(1)],

LRER LROP

Intercept Trend & Intercept None Intercept Trend & Intercept None

Level -2.2453(4)* 1.9059(4)* -2.5732(4)* -1.3240(1)* -2.9403(1)* 0.9202(1)* [-2.8854] [-3.4473] [-1.9434] [-2.8848] [-3.4464] [-1.9434] First Difference -5.9744(3)* -6.1816(3)* -5.7609(3)* -7.9394(0)* -7.9050(0)* -7.8566(0)* [-2.8854] [-3.4473] [-1.9434] [ -2.8848] [-3.4464] [-1.9434]

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ft

x

(

q

f x1) ve

z

bt (

p

bx1) vectors are first degree different stable [I(1)] series. Because the RER and ROP series are [I(1)] in this study,

x

ft

(

p

f

1)

and

Z

bt

(

q

b

1)

are used in the model. Based on this,

the model would become;

' '

t j bt bj ft f t

y

c

z

x

u

(

t T

j 1

1,..., )

T

j (5)

because

p

f

q

f

0

.

T T

1, 2, ....

T

mrefer to the break dates under m structural break and these dates are

unknown. For and coefficients, each break represents the following equation that points to the total of residual squares: m+1 t 1 2 m i=1 1

S (T ,T ,...T )=

i

1

[

t ft f bt t i

T

y x

z

T

(6)

In this equation,the break points are estimated by insertion of the estimated values of j

)

ve j

)

in

the third equation.The m is tested up until the values minimizing the total of residual squares (

T T

1, 2, ....

T

m),

T T

i i 1

q

) and it gives m break dates for the estimator (Ketenci, 2012).

Kejiriwal-Perron (2008, 2009) used DOLS method offered by Saikkonen (1991) andStock-Watson (1993)against the internalization problem that may occur in stable series at the first difference(Kejiriwal & Perron, 2008; Kejiriwal & Perron, 2009; Saikkonen, 1991; Stock & Watson, 1993).

' lT ' *

yt cj zbt bj j zbt j bj ut

lT (7)

IfTi 1 t Tifor t breaks, i=1,2,..k+1 veT0 0 and

T

m 1

T

.

For the first-degree stable series, (Kejriwal-Perron 2008)used sequential procedure offered by BaPerron(Kejiriwal & Perron, 2008). Test statistics UDmaxveWDmaxoffers that there is no break of test statistics; null hypothesis is tested against unit hypthoesis suggesting that there is alternative hypothesis in the interval

1

m M

. 1.... max 1 1 ( )

( , )

max sup

( .... : )

m t T m m M K

UD

FT M q

F

q

(8) 1.... max 1 1 ( )

( , ,1)

( , ) max

sup

( .... : )

( , , )

m t T m m M K

c q

WD

FT M q

x

F

q

c q

m

(9)
(6)

M represents the upper limit of the number of breaks. At the final stage, the following detects that there are k breaks in the null hypothesis and that there are k+1 breaks in the alternative hypothesis:

( 1| ) max sup { ( ....,1, )} { ( ,...,1 1, , ,..., )}/ 1 1 SEQ k k T SSR T T SSR T T T T SSR T k m T k T j j k k j (10)

The model in equation (10);

{ : ( ) ( ) }

, T 1 T T 1 T T T 1

j j j j j j j is obtained by global minimization of the combination of the residual squares in accordance with Bai-Perron (1998).

Tablo2 Kejriwal - Perron (2009) Test Results

Number of breaks under LWZ selection criteria developed as the advanced form of Schwarz criteria by Liu, Wu and Zidek (1994) used in the Bai Perron (1998) multiple break test(Bai & Peron, 1998; Liu, Wu, & Zidek, 1994).

yt

represents dependent variable,

zt

independent variable, q number of stable series at [I(1)], p number of stable series at level [I(0)], h number of minimum observations in every regime, M maximum number of breaks. The values in the bracketed parantheses represent the standard errors. At the Table,

c

1,

c

2,

c

3represent fixed terms whereas R2 is the identification coefficient, 1, 2, 3the coefficients of independent variables for all three regimes. Table 2 shows that there are two structural breaks in April 2004 and December 2007. The 1 pct of increase in the real oil prices during the period between Feb 2001 and April 2004 led to -0.739 pct decline in the real exchange rate. The 1 pct of increase Specifications

t

y

={Real exchange rate (LRER)},

z

t={2,Real oil proices (LROP)}, q=2, p=0, h=16, M=5 Test results 1stbreak 2004 2ndbreak 2007 1

c

1

c

2 2

c

3 3 1.658 [0.031] -0.739 [0.029] 1.99 [0.031] -1.794 [0.356] 2.119 [0.565] -4.263 [1.029] 2

R

= 0.402

R

2=0.681

R

2=0.699
(7)

in the real oil prices during the period between April 2004 and December 2007 led to -0.784 pct decline in the real exchange rate. The 1 pct of increase in the real oil prices during the period between December 2007 and July 2007 led to -4.263pct decline in the real exchange rate. In addition, there are three co-integration, in other words, long term relationships. A wholesale review on these three periods shows that oil prices have increased steadily since 2001; and current exchange rate has been positively affected by this impact. Even though it appears that the increases in the oil prices have created positive impact upon the currency exchange rate, in the long term, the increase in the oil prices leads to decline in the US dollar exchange rate. Particularly in the oil importing countries, its impact becomes even bigger because the increase in the real oil prices will lead to decline in the amount of oil to be purchased in terms of US dollar.

4. Conclusion

Since early 1990s, Turkish economy has been integrating with the global economy. The grave economic crises experienced in early 2000s in terms of macro-economic indicators were addressed by economic stability program and policies. Transition to strong economy program implemented in the aftermath of the Feb 2001 financial crisis sought to attain nationwide economic stability. The bureaucrats of the time announced that political stability was needed for the proper implementation of the program; to this end, the government decided to hold early elections; after the election, the parliament outlook was renewed. In the new parliament after the elections, a single party government was formed and this government started to implement an urgent action plan on Jan 3, 2003.

As a result of the implemented policies and measures, chronic inflation problem was taken under control by the end of 2004 and higher amount of growth and exports was attained; but despite this progress, the fragile structure in the economy was not eliminated .On the other hand, the decisive implementation of the economy policies by the political administration led to stability in the currency rate. It is considered that the fragility in April 2004 was caused by the positive impacts of the economic stability policies.

-year long stand-by program that seeks to maintain stable growth, low rate inflation and additional employment shows that fragility in economy persists [33]. However, the Global Financial Crisis which broke out in 2008 has strongly affected all economies in the world. Turkey whose exports are mostly composed of industrial products is the least affected by the crisis; however, it still imports investment goods used in production and energy needed in the industrial production. The global financial crisis has also negatively affected oil markets. It is considered that the break in December 2007 was caused by this external shock. The increase in the real oil prices has negatively affected the real exchange rates.

Acknowledgment

Authors would like to thank to Dr. for their

helpful comments and contribution to this paper. References

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ss 47 78.

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-Rochester Conference Series on Public Policy, Vol. 41, pp. 1 56.

Demez, S. M. -

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Liu, J., S. Wu, and J.V. Zidek (1994), "On Segmented Multivariate Regressions," Department of Statistics, University of British Columbia

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Conference

References

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