export price competitiveness and exchange rate risk

7/29/2019 Export Price Competitiveness and Exchange Rate Risk

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Export Price Competitiveness and

Exchange Rate Risk in Pakistans

Manufacturing Sector

Uzma Zia

Pakistan Institute of Development Economics


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Introduction

The globalization of markets involves intensification ofinternational competition that is forcing countries to becompetitive in export markets.

Competitiveness concerns stand high on the agenda ofnational governments and the concept of competitivenesshas attracted a lot of attention.

Improved competitiveness of economies in general and

firms and their products in particular is a need of the day.

The ability of products/firms to compete in the worldmarket is a major concern for policy makers.


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Contd

Competitiveness assessments are important inevaluating a countrys macro economic performanceand for evaluating sustainability of its policies.

Various measures to estimate competitiveness

Trade Related (RCA,CMS)

Productivity Related (TFP)

Efficiency Related (Stochastic Production

Functions) Price Related (Relative Trade Prices, Unit Labour

Cost, Real Effective Exchange Rate)


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Objectives

Main aim is to study export-price competitiveness ofPakistans manufacturing sector and motivationcomes from my earlier work by cointegration

analysis on this issue.

More specific objectives are:

To analyze Pakistans trade pattern and factorsaffecting export-price competitiveness.

To see effects of exchange rate volatility/risk onexport-price.


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Assessment of Export-Price

Competitiveness

Export-Price Competitiveness is mainly assessed by

the following :

Import prices

Unit labour cost

Exchange rate


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Exchange Rate Volatility/Risk

Exchange rate volatility play an important role inexport performance.

Increased volatility in exchange rate is assumed

to result in increased uncertainty about futureprofitability of a firm/exporter.

The volatility has an impact on decisions of thefirms that are engaged in trade, if the firms arerisk averse.

Standard theory assumes that exchange rate riskdepresses international trade.


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Review of Studies available internationally and for Pakistan on measuring Competitiveness

AuthorCountry Study Period Method/Technique Remark

Mehmood (2004) Pakistan 1990-2000 Trade related measure:Revealed comparative

advantage (RCA) approach.

Analyzed comparative advantage

and disadvantage ofPakistans non

agriculture production sectors

Ara (2004) Pakistan 1972-73 to 2002-03 Trade related measure:Revealed comparative

advantage (RCA) approach.

Assessed cost competitiveness ofmanufacturing sector of Pakistan

Hanif and Jafri

(2006)

Pakistan 1974-2004 Trade related measure:Balassa Index

Explored relationship of financial

sector development and

international trade competitiveness

in Pakistan

Chowdhury, (2005) Bangladesh,India, Pakistan

and Srilanka

1960-2000 Price related measure:Construction of real exchange

rate indices.

Measured intra-regional and

international trade competitiveness

for four SAARC nations

Brunner and Cali

(2006)

South Asian and

OECD countries

1991-2002 Price related measure /Unit valuemethod:

Comparative analysis

Analyzed export competitiveness

and export quality of South Asian

countries manufacturing relative to

OECD countries

Abeysinghe and

Yeok (1998)

Singapore 1980-1993 Price related measure:Price Competitiveness

method

Empirically shows export

competitiveness in Singapore

Harding (2001) Australia 1970-2000 Price related measure:Price Competitiveness

method and

Real Trade Weighted

Index of Exchange rate

Assessed Australias price

competitiveness and structural change

Fang and Miller

(2007)

Singapore 1979-2002 Price related measure:

Price Competitiveness

method

Finds relationship between exchange

rate depreciation and exports in

Singapore

Lakshmanan (2007) India 1980-81 to 2003-04 Price related measure:


method

Provides analytical analysis of

parameters of manufacturing

competitiveness in India

Chowdhury (1993) G-7 countries 1973-1990 Price related measure:


method

Examines exchange rate volatility on

trade flows of G-7 countries.


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Methodology

The empirical analysis is performed in two parts:

Assessment of exchange rate changes onexport-price competitiveness of Pakistans

manufacturing sector.

Exchange rate risk analysis for exportcompetitiveness.

Empirical methodology followed in thisresearch is adapted from Abeysinghe and Yeok(1998) with certain modifications.


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Model I Export Price Competitiveness

Px,t Export price index in year t.Pm,t Import price index in year t.SBRTx,t Export subsidies in year t.UBCt Unit business cost in year t.

)1(lnlnlnln ,,32,10, txtxttmtX PSBRTUBCPP


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Modifications

Abeysinghe and Yeok has taken UBC as compositeindex of unit labour cost, services cost, andgovernmental rates and fees. In this research UBC is(based on employment cost and cost of electricity

and fuel--Index is made by dividing these costs byvalue added in the manufacturing sector).

There are no export subsidies in Abeysinghe modelbut in case of Pakistan subsidies are importantdeterminants of exports. Export subsidies that reflect

the extent to which price paid by foreign importersof the exportable is reduced (captures the impact ofexport promotion policies.)


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Model-II: GARCH-M

To investigate volatility in exchange rate, theGARCH(1,2)-M based on SC criteria model isused to capture the effects of the exchange ratethrough import prices on export-pricecompetitiveness.

An important application of ARCH andGARCH models is to measure and forecast the

time varying volatility.


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ttt

txtmotx

UfUBC

SBRTPP

)( 243

,21,1,

GARCH-M: Mean and Variance

Equation

Mean Equation:

This equation shows the relationship between export-price,

import-price, export subsidies and unit business cost. In

addition, the coefficient 4 measures the trade-off between

exchange rate risk and export competitiveness, in other

words it explains the needed compensation to exporter for

facing exchange rate risk.


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Contd

22

1

2

ititOt

Variance Equation:

This equation captures the effect of volatility in export

competitiveness due to exchange rate risk captured by

import-price.


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Data

Variables needed for this research are:

Export price index (Px)

Import price index (Pm)

Export Subsidies (SBRTx) Unit business cost (UBC)

Annual data used are from 1970-2008.

All time series data are tested forstationarity using ADF test.


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Data Sources

Censes of Manufacturing Industries(CMI)

Statistical Year Book of FederalBureau of Statistics (FBS)

International Financial Statistics(IMF)

CBR Year Book

Economic Survey (various issues)


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Estimation Procedure

1- Augmented Dickey Fuller (ADF)non stationary-Logfirst difference.

2- Relationship by estimating multivariate regressionmodel by Ordinary Least Square (OLS).

3- Exchange rate risk analysis by applying GeneralizedAutoregressive Conditional Hetroscedasticity(GARCH).


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Stationarity

The ADF test indicates the acceptance ofthe unit root hypothesis at level, that is, thetime series have a unit root.

The results indicate the first differences ofvariables of export price, import price,export subsidies rate and UBC are on astationary process, as the null hypothesis ofunit root is rejected. Hence, these series areintegrated of order 1, i.e., d(1).


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Relationship between export-price

competitiveness and its determinants

Note: * indicates statistical significance at 1% level. ** indicates statistical significance at 5% level.

Variable Coefficient t-stat

Import Price (Pm) 0.71* 5.89

Export Subsidies (SBRTx) 0.03 1.36

Unit Business Cost (UBC) -0.49* -2.17

Export Price (-1) 0.22** 1.71

Constant 2.15 2.09

0.98

Durbin-Watson statistic 1.74

F-statistic 676.45

Adjusted R2


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Relationshipby OLS

Relationship - estimated by regressing export-price onimport-price, export subsidies and UBC.

OLS technique is used.

Results show:

Import prices - positively and significantly associatedwith export price competitiveness.

Subsidies - positively but insignificantly associated withexport competitiveness.

Unit business costnegatively and significantly affectingthe export competitiveness.

Lag of exports- positively and significantly affectingexport competitiveness.

Analysis shows significance of import-price (also

reflecting changes in exchange rate) and UBC on export-price competitiveness.


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Contd

The relationship between export-price and import-priceis positive because the lower import content in the

production of exportables allows exchange ratedepreciation to significantly impact the export-pricecompetitiveness. (Overall devaluation of Pak currency

viz a viz US dollar is 7.61 percent in 1972-2008).

In addition to exchange rate changes, productivitygains also contribute to enhance exportcompetitiveness. (Overall average of TFP growth rate

is 1.81 percent in 1972-2008).

Thus positive changes in domestic value added in thepresence of currency adjustment play an importantrole in improving export-price competitiveness.


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Export-price competitiveness with GARCH (1, 2)-M

Coefficient Z-statistic

Mean Equation:

GARCH-M 0.108*** 2.073

C 1.480*** 1.884

Pm 0.522** 9.366

SBRTx 0.071** 3.894

UBC -0.365** -2.182

Export(-1) 0.374** 7.205

Variance Equation:

C 0.0014*** 0.619

ARCH(1) 0.804 1.486

GARCH(1) -0.298*** -1.708

GARCH(2) 0.385*** 1.695

Adjusted R-squared 0.98

Note: ** indicates statistical significance at 5%. *** indicates statistical significance at 10%.


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GARCH-M

Import Price Index calculated on the basis of domestic currencycaptures variability in exchange rate.

GARCH-M term is positive and significant indicating thatexchange rate risk has positive and significant compensation ofrisk on export competitiveness.

Variance equation explains how much variance is affected by thepast lag residuals and how much is influenced by past variance.

GARCH (1) significant

GARCH (2) significant

The significance of GARCH terms shows previous variance issignificantly contributing to current variance.

Exchange Rate depreciation risk decreases export-pricecompetitiveness.


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Conclusion

Conclusions are:

Exporters react differently to the exchange rate and itsassociated risk. Findings reveal that exchange rate risk has

positive and significant compensation, affecting export

competitiveness.

In case of Pakistan we find that the exchange rate risk alsoinfluence export price and the domination of exchange raterisk leads to a decrease in export competitiveness resulting

into weak export growth.


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Policy Recommendations

The analysis of this study leads us to several policy implications:

Policymakers need to carefully watch movements in import pricesdenominated in local currency, and export subsidies. There is aneed to create a synergy between trade policy and exchange rate

policy. Reduction in exchange rate fluctuations and reducing anti-

export bias will be desirable policy instruments.

Policy makers may consider prudent foreign exchange marketinterventions since exchange rate risk factor do offset positiveeffects of depreciation.

The government may take measures to enable exporting firms inupgrading and meeting international standards by streamliningtechnology development. This would enable industries to achievehigh growth in total factor productivity.


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Thank You

export price competitiveness and exchange rate risk

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