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Malaysia Exports to Singapore:

Causal Relationship with GDP and Exchange Rate

By

Siti Zarinah Salmo (G0000000)


Masripan Salleh (G0921339)
Lokman Effendi Ramli (G0927179)
and Dr. Abdullah Al-Hajjaji (G1111111)

Management Center, International Islamic University, Malaysia

Abstract

The main objective of this study is to examine the impact on Malaysia’s Exports
to Singapore as a result of Singapore’s GDP performance and volatility of
Exchange Rate of Ringgit Malaysia (against US Dollars). Concurrently, this
study investigates causal relationship between Malaysia’s Exports (RXSPO) as
dependent variable and Singapore’s GDP (RSPOGDP) and Exchange Rate
(RRMUSD) as independent variables. The data for this study was obtained from
International Financial Statistic (IMF) World Economic Database, Central Bank
of Malaysia and Department of Statistic, Malaysia. Cointegration, Error
Correction and Causal Granger techniques are adopted extensively for this
study. The findings of this study reveal that 97.54% of total variations of
Malaysia’s Real Exports to Singapore can be explained by the proposed
regression model with Singapore’s GDP and Exchange Rate as the independent
variables. In addition, the model is proven statistically significant and
cointegrated in the long run, where an increase of 1% in Singapore’s GDP is
expected to attribute to 0.8353% increase of Malaysia’s Export to Singapore;
and an increase of 1% in the Exchange Rate (appreciation of RM to USD) is
expected to decrease Malaysia’s Exports to Singapore by 0.7341%. Error
Correction Term (ECT) Coefficient of -0.58631 suggests that Malaysia’s export
to Singapore will converge towards its long run equilibrium level in a moderate
speed after any volatility in Singapore’s GDP or Exchange Rate. Both
Singapore’s GDP and Exchange Rate have one direction Causal Granger
relationship to Malaysia’s Exports to Singapore whereas both Singapore’s GDP
and Exchange Rate establish bi-direction of Causal Granger relationship
between them.

1
1.0 INTRODUCTION

Malaysia, as an open economy, has been very much dependent on foreign trade
to achieve its economic development goals. Foreign trade has accounted for a
significant and rising trend of its gross domestic product (GDP) in the last three
decades, indicating that international trade has been playing an important role in
the development of Malaysian economy. The share of merchandise trade in GDP
was 73% in 1970, increased by 172% in 1995, and increased further by 202% in
20001. If we consider the share of the merchandise trade in GDP as an indicator
of trade liberalization, Malaysia certainly has gone through a relatively rapid
process of trade liberalization and globalization. Indeed, the decision made by
Malaysia to implement the export-oriented development strategy beginning in
1980s has been the major vehicle that has transformed Malaysia from the
primarily commodity based economy to an industrial based economy.

According to World Economic Forum (WEF), currently Malaysia was ranked 24th
best trading nation in the world (Enabling Trading Index – ETI), with a trade value
of USD 281.3 billion2. However, Malaysia world trade share was reduced from
1.2% to 1.1% as compared to the previous year due to the global economic
challenges. In order to maintain its trading position and trade volumes, Malaysia
must optimize any available opportunities to export more of its products,
especially to its leading trading partner, Singapore.

As expected, its traditional bilateral trading partners (Singapore, USA, EU27,


Japan and China) are the main contributors (as per the table below)3.

1
Yusoff, Mohammed, Malaysia Bilateral Trade Relations and Economic Growth, International Journal of Business
and Society,

2
The Global Enabling Trade Report 2010, World Economic Forum,
http://www.weforum.org/en/initiatives/gcp/GlobalEnablingTradeReport/index.htm
3
Ibid

2
Since 2008, Singapore has taken over USA to become Malaysia’s largest
bilateral trading partner. Export to Singapore alone represented 14% of total
national exports where 58.3% of exports to Singapore are mainly electrical and
electronic components and refined petroleum products. In-line with global
practice, most transactions use USD as the preferred currency4.

Malaysia-Singapore relationship as a trading partner is very significantly


important due to close and symbiosis relationship since prior independence
where Singapore was part of Malaysia. Both countries have common culture and
interest and equally important, they are sharing a lot of similarities in history,
economy, social and politic.

In terms of bilateral relationship, Singapore relies heavily on Malaysia for the


supply of raw materials & components and finished and unfinished products. As
an established trading hub for the Asean region, Singapore would re-export

4
The Global Enabling Trade Report 2010, World Economic Forum,
http://www.weforum.org/en/initiatives/gcp/GlobalEnablingTradeReport/index.htm

3
Malaysia’s products to other part of the world in particular electronics and
petroleum products; and agriculture based products, such as palm oil, foods,
fruits and vegetables. On the other hand, Malaysia is heavily dependent on
Singapore’s reputation and infrastructure, ranked as the world’s no. 1 in trade
enabling nation. Therefore, it is critical for Malaysia to continue expanding its
global trade via Singapore until such time when Malaysia achieves full
international recognition or could match Singapore’s outstanding performance in
international trade.

Since Malaysia’s Exports to Singapore is critical for attaining continued growth in


international trade, it is therefore a motivation for this study to investigate the
impact on Malaysia’s Exports to Singapore as a result of Singapore’s GDP
performance and the volatility of Exchange Rate.

Problem Statement

In the WEF report on “Global Enabling Trade” published recently (2010),


Malaysia ranked 24th in the world as compared with its trading partner, Singapore
which is ranked 1st in the world5. As such, it is crucial for Malaysia to explore
thoroughly the factors affecting Malaysia’s Exports to Singapore so that trade
volumes (exports) could be sustained or further improved. For this study,
Singapore’s GDP and volatility of Exchange Rate are being investigated for their
causal relationship with Malaysia’s Exports. We hope that the outcome of this
study could lead to better understanding on how bilateral trade (exports) could be
further improved with Singapore.

5
The Global Enabling Trade Report 2010, World Economic Forum,
http://www.weforum.org/en/initiatives/gcp/GlobalEnablingTradeReport/index.htm

4
Objectives of Study

The objectives of the study are:


 To examine the effect of Singapore’s GDP and volatility of Exchange Rate
to Malaysia’s Exports to Singapore.
 To examine causal Granger relationship among the variables in the linear
model.
 To come up with a cointegrated linear model of Malaysia’s Exports where
Singapore’s GDP performance and Exchange Rate as variables.
 To advise the Government of Malaysia on how to exploit Singapore’s
global position to increase Malaysia’s Exports to Singapore.

2.0 LITERATURE REVIEW

We found that there are many literatures available on this subject where volatility
of exchange rate and Gross Domestic Product (GDP) has some impact on trade.
The following summarizes some of the literatures we have reviewed:

Yusoff M (2005) conducted a study to determine the effects of exchange rates on


Malaysian trade balance with the USA, Japan and Singapore using cointegration
and error correction techniques. The short run dynamics were analyzed by using
VECM to see the impact of exchange rate on the trade volume. His findings
confirmed that trade balance, real exchange rates and income are cointegrated
and the estimated long run trade balance indicated that exchange rate is
significant and has a positive sign. In addition, the depreciation of RM could
stimulate exports and discourage imports; and therefore could improve trade
balance for Malaysia, as in the case with Singapore.

Sukar, A (1999) noted that the effect of exchange rate volatility was a
controversial issue in international economics and there was no real consensus
on the direction or the size of the exchange rate volatility and trade relationship.

5
He also stated that the exchange rate volatility increased risk and uncertainty and
therefore could hamper the flow of trade and investment. His findings confirmed
that volatility in real exchange rates has an adverse effect on the trade flow in the
long run. The empirical results based on cointegration analysis showed that USA
export volume is cointegrated with foreign income, real exchange rate, and
exchange rate risk. It confirmed that there was indication of significant negative
relationship between US export volume and exchange rate volatility.

Halicioglu F (2007) conducted empirical study on the dynamics of Turkish


bilateral trade between Turkey and her trading partners using a cointegration
approach. He cited that there was relationship between exchange rate and the
trade balance but stressed that empirical results have been rather ambiguous.
He noted a theoretical suggestion that changes in exchange rate would effect on
trade flows, price and volume. His findings stated that the empirical results
suggest non-existence of the J-curve effect at disaggregate and aggregate
levels. The results of some bilateral long-run relationships suggested that
currency depreciation might improve trade balance.

Rey S (2006) investigated the impact of nominal and real effective exchange rate
volatility on exports of six Middle Eastern and North African (MENA) countries to
EU countries for the period 1970 to 2002. The cointegration results indicate a
significant relationship (either negative or positive) between exports and
exchange rate volatility. Further, the cointegration results show that exports are
cointegrated with the relative price (real effective exchange rate), GDP and
exchange rate volatility. Using an error correction model, he stated the short run
dynamics shows that Granger-causality effects of the volatility of exchange of
rate on real exports are significant. An interesting citation, he referenced
McKenzie (1997) that effects of the nominal exchange rate volatility on Australian
exports change according to the direction of trade; positive effects on exports to
USA, Japan, United Kingdom and Singapore.

Sekkat & Masnour (2005) examined the likelihood of asymmetric shocks in


Europe originating from the impact of exchange rate fluctuations on trade. It

6
conceptualized that for such asymmetric shocks to occur, exchange rate
fluctuations must have different impacts across sectors. The asymmetric shock
may occur if the effect of any change in the Euro policy differs across countries.
This literature has no direct relationship to the study that we undertake that
focuses on relationship between exports and GDP and volatility of exchange rate.

Breden, Fountas & Murphy (2003) conducted analysis both the long-run and
short-run relationship between merchandise export volume and its determinants,
foreign income, relative prices and exchange rate volatility using cointegration
and error correction techniques. They found that exchange rate volatility has no
effect on the volume of trade in the short run but a significant positive effect in the
long-run. They could conclude that the decline in intra-EU exchange rate volatility
associated with the single currency would lead to a long-run fall in Irish exports to
the EU. This study restricts itself to examining the effect of exchange rate
variability on exports, although an examination of overall trade would allow better
analysis of the contributing factors that influence the trade.

This paper analyses the long-run and short-run relationship between export
volume and its determinants; namely, relative prices, foreign income and
exchange rate variability, using the techniques of cointegration and error-
correction methods. The results show that exchange rate volatility has no effect
on the volume of trade in the short-run but a significant positive effect in the long
run.

Based on the above literatures, we could conclude that various studies have
been done to study the impact of exchange rate, GDP and other factors on
exports. This experience and knowledge are invaluable and could be utilized for
us to conduct our study to investigate the impact on Malaysia’s Exports to
Singapore in relation to Singapore’s GDP and the volatility of Exchange Rate
(USD-RM).

7
3.0 MODEL AND DATA ANALYSIS

3.1 MODEL SPECIFICATIONS

The study focuses on Malaysia’s Exports to Singapore in relation to volatility of


Exchange Rate (RM-USD) and Singapore’s GDP. The model underlying our
empirical analysis is based on the following simple export equation:

lnYt = α + β1lnX1t + β2lnX2t + εt

Alternatively, we could use

ln(RXSPOt) =  +  ln(RSPOGDPt) + In(RRMUSDt) + εt (Equation 3.1.1)

where,

RXSPO is the Malaysia’s Exports to Singapore in real price

RSPOGDP is Singapore’s Gross Domestic Product (GDP) in real price

RRMUSD is Exchange Rate (number of US dollars per Ringgit Malaysia).

Hypotheses

Impact of Singapore’s GDP on Malaysia’s exports to Singapore


Ho : Singapore’s GDP not influence Malaysia’s exports to Singapore
H1: Singapore’s GDP influence Malaysia’s exports to Singapore

Impact of exchange rate on Malaysia’s exports to Singapore


Ho : RRMUSD not influence Malaysia export to Singapore
H2: RRMUSD influence Malaysia’s exports to Singapore

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3.2 DATA ANALYSIS

We will attempt this study in two parts. The first part in this empirical study is to
identify the stochastic properties by running the following tests:

Normality Test: Normality test using Jarque-Bera (JB) statistics. The null
hypothesis; Ho: the residuals are normally distributed. An alternative hypothesis,
H1: residuals are not normally distributed.

Residual Autocorrelation Test: We employ Busch-Godfery LM-test and Durbin-


Watson test, with the null hypothesis; Ho: no autocorrelation in the disturbance
term, and alternative hypothesis, H1: has autocorrelation in the disturbance term.

Heteroskedasticity Test: We use White test with null hypothesis; Ho: the
variance of the disturbance term is homoskedastic, and alternative hypothesis,
H1: the variance of the disturbance term is heteroskedastic.

Parameter Stability Test: We use both CUSUM Test and CUSUM of Square
Test to produce informative plots about the stability of the structure. Null
hypothesis; Ho: the parameter is constant and alternative hypothesis, H1: the
parameter is not constant. Expectation of the CUSUM statistics is zero under null
hypothesis of constant parameters.

The second part of this statistical analysis is to perform relevant tests based on
time series data as follows:

Unit Root Test: We use both Augmented Dickey Fuller (ADF) test and Phillips-
Perron (PP) unit root tests to test for stationary of the variables or for determining
the variables order of null hypothesis; Ho: the variable is non-stationary and
alternative hypothesis, H1: : the variable is stationary. If the variables are
integrated of order one, I(1), then proceed with cointegration tests.

9
Cointegration Test: We use Johansen and Jusellius test to identify whether
variables are cointegrated where, null hypothesis; Ho: the variables are not
cointegrated and alternative hypothesis, H1: the variables are cointegrated. If two
variables are cointegrated of order one, they can be modeled by an ECM to
determine the long-run relationship between two or more variables.

Based on above, the following is the estimated equation:

∑ ∑ ∑
∑ (Equation 3.1.2)

Granger Causality Test: We use Block Exogeneity-Wald test to identify whether


variables has Granger causality relationship among them. The hypotheses are as
below:

Granger causality relationship Singapore’s GDP to Malaysia’s Exports to


Singapore:

Ho: Singapore’s GDP has no causal Granger relationship to Malaysia’s export to


Singapore.
H1: Singapore’s GDP has causal Granger relationship to Malaysia’s Exports to
Singapore

Granger causality relationship Exchange Rate to Malaysia’s Exports to


Singapore:

Ho: Exchange Rate has no causal Granger relationship to Malaysia’s Exports to


Singapore.
H2: Exchange Rate has causal Granger relationship to Malaysia’s Exports to
Singapore.

10
Granger causality relationship Malaysia’s Exports to Singapore to
Singapore’s GDP:
Ho: Malaysia’s exports to Singapore has no causal Granger relationship to
Singapore’s GDP
H3: Malaysia’s exports to Singapore has causal Granger relationship to
Singapore’s GDP

Granger causality relationship Malaysia’s Exports to Exchange Rate:


Ho: Malaysia’s Exports to Singapore has no causal Granger relationship
Exchange Rate
H4: Malaysia’s Exports to Singapore has causal Granger relationship to
Exchange Rate

3.3 EXPECTED RESULTS

The Impact of Singapore’s GDP on Malaysia Exports to Singapore

Singapore’s GDP is expected to have a significant positive relationship with


Malaysia’s Exports to Singapore, where any increase in the GDP is expected to
increase in the demand for Malaysian products.

Malaysia's Exports to Singapore Vs Singapore GDP


200.0
180.0
160.0
140.0
120.0
Billion

100.0
80.0
60.0
40.0
20.0
0.0
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009

Malaysia's export to Singapore (RM) Singapore GDP (USD)

11
The Impact of Exchange Rate (USD/RM) on Malaysia Exports to Singapore

The volatility of Exchange Rate is expected to have a significant negative


relationship with Malaysia’s Exports to Singapore, where any decrease in the
value of Ringgit Malaysia is expected to increase in the demand for Malaysian
products.

Malaysia's Exports to Singapore Vs Exchange Rate (RMUSD)


Billion
RMUSD
120.0 0.500

0.450
100.0
0.400

0.350
80.0
0.300

60.0 0.250

0.200
40.0
0.150

0.100
20.0
0.050

0.0 0.000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Malaysia's export to Singapore (RM) Exchange Rate (RM per unit USD)

3.3 DATA AND SOURCES

This study uses annual data for the period of 1980-2009. Data on Malaysia’s
Exports to Singapore was obtained from Department of Statistic, Malaysia. Data
on Singapore’s GDP and CPI are obtained from International Financial Statistics
(IFS) World Economic Database (WEO, April 2010). Data for the Exchange Rate
of USD-RM is gathered from the Central Bank of Malaysia, where:

i) Malaysia’s Export to Singapore (RXSPO) = Malaysia’s nominal


exports to Singapore / Consumer Price Index of Malaysia *100;

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ii) GDP of Singapore (RSPOGDP) = Current GDP of Singapore in USD
/ Consumer Price Index of Singapore *100;
iii) RRMUSD=Real exchange rate between USD and RM (defined as
(Pm.NEXt)/Pt, where Pm is Malaysia’s CPI, Pt is the US CPI, NEXt is
the nominal exchange rate (the number of RM per USD)

4.0 RESULTS AND DISCUSSION

4.1 DESCRIPTIVE ANALYSIS

Jarque-Bera Test
Jarque-Bera Test is goodness-of fit measure of departure from normality based
on the sample kurtosis and skewness. The results show that we fail to reject null
hypothesis Ho. This means the residuals are normally distributed at 99%
confidence level.

LRXSPO LRSPOGDP LRRMUSD


Mean 3.464141 4.062485 -1.085895
Median 3.714946 4.372534 -1.052091
Maximum 4.380008 5.111981 -0.707088
Minimum 2.220952 2.853741 -1.370822
Std. Dev. 0.751970 0.719900 0.221257
Skewness -0.388859 -0.307918 0.050867
Kurtosis 1.598058 1.721944 1.606147

Jarque-Bera 3.212858 2.515849 2.441470


Probability 0.200603* 0.284243* 0.295013*

Sum 103.9242 121.8745 -32.57684


Sum Sq. Dev. 16.39831 15.02943 1.419681

Observations 30 30 30
*Represents statistically not significance at the 1% level based on adjusted data
due to economic crisis during 1997-2003.
Note: The critical values for the tests are based Monte Carlo simulation by using
Matlab software, n=30

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In order to get a normally distributed residual, we have to identify the outliers and
create dummy variables with strong economic reasons (i.e. economic crisis
during 1997-1998). It does neither make sense nor practical to eliminate every
disturbing observation. Alternatively, we could increase the number of
observations from the present 30 observations.

Residual Autocorrelation Test


Based on Busch-Godfery LM-test, the BGLM has p-value of 0.0106, which
means that we fail to reject the null hypothesis at 1% significant level. We
conclude there is no autocorrelation in the disturbance term.

Breusch-Godfrey Serial Correlation LM Test:


F-statistic 4.778646 Probability 0.009477
Obs*R-squared 11.21867 Probability 0.010600

Test for Heteroskedasticity


Based on the White test where the p-value is 0.0758, we fail to reject the null
hypothesis of homoskedastic disturbance at 1% significant level. We conclude
that the variance of the disturbance term is homoskedastic.

White Heteroskedasticity Test:

F-statistic 2.458109 Probability 0.071681


Obs*R-squared 8.468346 Probability 0.075853

Test for Stability


The CUSUM statistics are zero under the null hypothesis of constant parameter.
The CUSUM statistics plotted in with 5% confidence bounds (as below). The
Graph shows CUSUM statistics revolve around zero within its confidence bounds
the null hypothesis of parameters constancy are not rejected. The results show
that the parameters are constant.

14
16

12

-4

-8

-12

-16
84 86 88 90 92 94 96 98 00 02 04 06 08

CUSUM 5% Significance

The CUSUM of Square statistics are zero under the null hypothesis of constant
parameter. The CUSUM of Square statistics plotted in with 5% confidence
bounds (as below). The Graph showed CUSUM of Square statistics revolves
around zero within its confidence bounds the null hypothesis of parameter
constancy is not rejected. Based on the results, the model,

ln(RXSPOt) =  + ln(RSPOGDPt) + In(RRMUSDt) + εt


is stable at 5% significance bound.

1.6

1.2

0.8

0.4

0.0

-0.4
84 86 88 90 92 94 96 98 00 02 04 06 08

CUSUM of Squares 5% Significance

15
Relationship between dependent variable (RXSPO) and independent variables
(RSPOGDP and RRMUSD) is investigated using classical multi-regression
model. It is carried out as a comparison to the results which are derived from
other approaches.

Results of the estimate regression show that the variables are significant in
the long run (based on equation 3.1.1)

Summary of result
Coefficient Standard. Error Prob.
Constant -0.7265 0.1302 0.0000*
Log real SPOGDP 0.8353 0.0576 0.0000*
(LRSPOGDP)
Log real exchange Rate -0.7341 0.1876 0.0006*
(RRMUSD)
F-Statistics 535.4767 0.0000*
R-squared 0.9754
Durbin-Watson 0.6763

Notes; *(**)(***) indicate statistical significance at the 1%, (5%),(10%) levels


respectively
Dependent Variable = Real Malaysia’s Exports to Singapore (LRXSPO)

R-square (R2) of 0.975409 showing that 97.5% of total variation of Malaysia’s


Exports to Singapore (LRXSPO) can be explained by the linear model with real
Singapore’s GDP (LRSPOGDP) and Exchange Rate (LRRMUSD) as
independent variables. Overall model is significant at 1% significant level. All
independent variables are also significant at 1% significant level. Durbin-Watson
(DW) of 0.67632 shows that there is positive autocorrelation in the model.

From the model, LRSPOGDP has positive impact on Malaysia’s Exports to


Singapore. An increase of 1 % of Singapore’s GDP is expected to increase
0.8353 % of Malaysia’s Exports to Singapore (ceteris paribus). Exchange rate
has negative impact on Malaysia’s Exports to Singapore. An increase of 1% in
exchange rate (RM-USD) is expected to reduce 0.7341% of Malaysia’s Exports
to Singapore (ceteris paribus). In other word, when RM appreciates against USD

16
there is expected reduction in Malaysia Exports to Singapore (since Malaysian
goods become more expensive).

The regression equation can be written as follows:

LRXSPO = α + 0.8353*LRSPOGDP - 0.7341*LRRMUSD

Relationship between dependent variable (RXSPO) and independent variables


(RSPOGDP and RRMUSD) is also investigated by using cointegration, error
correction model and Granger causality effect.

Unit Root Test

Augmented Dickey-Fuller (ADF) and Phillip-Perron (PP) Unit Root Tests

(based on equation 3.1.2)

Variables ADF PP
Level First Second Level First Second
Difference Difference difference difference
LRXSPO -0.6579 -3.8683** -0.8841 -3.8683**
LRSPOGDP -1.8977 -2.8878 -5.5857* -1.4989 -2.8965 -6.1304*
ΔLRSPOGDP -2.8704 -5.6432* -2.8804 -6.1761*
LRRMUSD -2.4003 -4.2709* -1.7069 -4.1872*
Note: The critical values for the tests are based MacKinnon (1996).
*represent statistical significance at the 1% level.
** represent statistical significance at the 5% level.

Based on the results of ADF and PP tests, we fail to reject the null hypothesis
(the variable is non-stationary). Since LRSPOGDP was found stationary at
second difference I(2), we use the DLRSPOGDP. At 1% significance level, the
first-differences of these variables are found to be stationary. As such, we reject
the null hypothesis of non-stationary. This means we accept the alternative
hypothesis where the variables are integrated of order one I(1). Then we proceed
to perform cointegration test.

17
Cointegration Test

Johansen-Juselius Cointegration Tests Result (based on equation 3.1.2)


Critical Values (5%)
Hypothesiz
Trace Max-Eigen
e No. of
Statistics Statistics(lamda) Trace Max-
CE(s)
Eigen

None* 71.85999 36.74577 29.7972 21.1316

At Most* 35.11422 33.55567 15.4947 14.2646

At Most 1.5585 1.5585 3.8415 3.8415

* Rejection of the hypothesis at the 0.05 level.


CE : Cointegration equation

Note: We set lag order to five, which is sufficient to whiten the noise process. The
critical values are taken from Mackinnon-Haug-Michelis (1999)

The results show that null hypothesis of no cointegration is rejected at the 5%


level by both trace and the Max-Eigen value versions of Johansen approach. The
test indicates that these variables are cointegrated. As such, the long run
equilibrium relationship between Malaysia’s Exports to Singapore with real GDP
and Exchange Rate exists.

Johansen procedure is used to obtain the long run coefficient of the model.
Based on the results (table below), however, both LRSPOGDP and LRRMUSD
are not significant at 5% significant level.

18
Normalized Cointegrating Evigen vector (based on equation 3.1.2)
One Log
cointegrating Likelihood 143.3037
Equation
LRXSPO LRSPOGDP LRRMUSD

1.0000 -1.752546 -1.731456

(0.0000) (0.20722) (0.776846)

Short Run Analysis : An Error Correction Model

The results showed that the error term ECT in the short–run is statistically
significant at 10% with a negative sign, confirming that a long-run equilibrium
relationship exists between the variables. The motive of this analysis is to
discover whether the short-run dynamics are influenced by the estimated long-
run equilibrium conditions, which is cointegrating vectors.

Short run Vector Error Correction Model (VECM) (based on equation 3.1.2)
Variable Coefficient Standard t-ratio Probability
Error
ECT(-1) -0.586310 0.3125674 -1.942455 0.0644***
ΔLRXSPO(-3) 0.509998 0.261864 1.947564 0.0704***
ΔLRSPOGDP(-3) -0.975592 0.444821 -2.193225 0.0445**
ΔLRRMUSD(-3) 1.465882 0.515253 2.844978 0.0123**
Intercept 0.069814 0.065372 1.067952 0.3024
2
R 0.736552
DW 2.07976
F-statistics 4.193725 0.006425*

Notes; (*)(**)(***) indicate statistical significance at the 1%, (5%),(10%) levels


respectively

Based on the table, the VECM model is :

ΔLRXSPO = α + 0.50998*ΔLRXSPO(-3) -0.975592ΔLRSPOGDP(-3)


+1.465882*ΔLRRMUSD(-3) - 0.58631*ECT(-1)

19
R-square (R2) of 0.7366 showing that 73.66% of total variation of ΔMalaysia’s
Exports to Singapore (ΔLRXSPO) can be explained by the linear model with real
ΔSingapore’s GDP (ΔLRSPOGDP) and ΔExchange Rate (ΔLRRMUSD) as
independent variables. Overall model is significant at 1% significant level. All
independent variables are also significant at 1% significant level. Durbin-Watson
(DW) of 2.07976 shows that there is no autocorrelation in the model.

From the model, ΔLRSPOGDP has negative impact on ΔMalaysia’s Exports to


Singapore. An increase of 1 % of ΔSingapore’s GDP is expected to decrease
0.9756 % of ΔMalaysia’s Exports to Singapore (ceteris paribus). ΔExchange rate
has positive impact on ΔMalaysia’s Exports to Singapore. An increase of 1% in
ΔExchange Rate (RM-USD) is expected to increase 1.4659% of ΔMalaysia’s
Exports to Singapore (ceteris paribus).

A crucial parameter in the estimation of the short-run dynamic model is the


coefficient of the error-correction term (ECT), which measures the speed of
adjustment of Malaysia’s export to Singapore to its equilibrium level. The results
show that the parameter of the ECT in the model is statistically significant and
correctly signed. This confirms that the Malaysia’s Exports to Singapore has an
automatic adjustment mechanism. Error Correction Term (ECT) coefficient of -
0.58631 suggests that Malaysia’s Exports to Singapore will converge towards its
long run equilibrium level in a moderate speed due to any volatility in Singapore’s
GDP or Exchange Rate.

Granger Causality Test

Pairwise Granger Causality Test


Independents LRXSPO LRSPOGDP LRRMUSD
Dependents Chi-Sq (Prob) Chi-Sq (Prob) Chi-Sq (Prob)

LRXSPO 5.4762(0.0647) 6.7623(0.034)


LRSPOGDP 1.2181(0.5439) 5.6627(0.059)
LRRMUSD 2.8769(0.2372) 4.6177(0.0994)

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Ho: Singapore’s GDP has no causal Granger relationship to Malaysia’s Exports to
Singapore.
Reject null hypothesis at 10% significant level (0.0647<0.1). So, Singapore’s
GDP has causal Granger relationship to Malaysia’s Exports to Singapore (ceteris
paribus) at 10% Significant level (p<0.1).

Ho: Exchange Rate has no causal Granger relationship to Malaysia’s Exports to


Singapore.
Reject null hypothesis at 10% significant level (0.034<0.1). So, Exchange Rate
has Causal Granger relationship to Malaysia’s Exports to Singapore (ceteris
paribus) at 10% Significant level (p<0.1).

Ho: Malaysia’s Exports to Singapore has no causal Granger relationship to


Singapore’s GDP.
Since we fail to reject null hypothesis at 10% significant level (0.5439>0.1),
Malaysia’s Exports to Singapore has no causal Granger relationship to
Singapore’s GDP (ceteris paribus) at 10% significant level.

Ho: Exchange Rate has no causal Granger relationship to Singapore’s GDP.


Since we reject the null hypothesis at 10% significant level (0.059<0.1) Exchange
Rate has causal Granger relationship to Singapore’s GDP (ceteris paribus) at
10% significant level (p<0.1).

Ho: Malaysia’s Exports to Singapore has no causal Granger relationship to


Exchange rate.
Since we fail to reject null hypothesis at 10% significant level (0.2372<0.1),
Malaysia’s Exports to Singapore has causal Granger relationship to Exchange
Rate (ceteris paribus) at 10% significant level.

Ho: Singapore’s GDP has no causal Granger relationship to Exchange Rate.

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Since we reject null hypothesis at 10% significant level (0.0994<0.1), Singapore’s
GDP has causal Granger relationship to Exchange Rate (ceteris paribus) at 10%
significant level (p<0.1).

Based on causal Granger analysis, Singapore’s GDP and Exchange Rate have
one direction Causal Granger relationship to Malaysia’s Exports to Singapore.
However, both Singapore’s GDP and Exchange Rate have bi-directional Causal
Granger relationship between them.

Malaysia's Exports
to Singapore
(RLXSPO)

Exchange Rate Singapore's GDP


(RRMUSD) (RSPOGDP)

5.0 CONCLUSION AND RECOMMENDATIONS

This paper utilizes an empirical analysis to examine the effect of Singapore’s


GDP and the volatility of Exchange Rate (RM-USD) to Malaysia’s Exports to
Singapore, utilizing 30 observation samples from 1980 to 2009. The first step of
data analysis involves identifying the stochastic properties of the data by running
Normality test, Autocorrelation test, Heteroskedastic test and Parameter test.

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Then, we investigated the relationship between dependent variable and
independent variables through Unit Root test, Cointegration test, Error Correction
model and Causal Granger test.

We found that the stochastic properties of the data are excellent where the
residuals are normally distributed; no autocorrelation, homoskedastic and the
parameters are stable. The results show that the variables are stationary and
cointegrated. The results indicate that the long run equilibrium relationship
between Malaysia’s Exports to Singapore with Singapore’s GDP and Exchange
Rate exist. The results also show the error term ECT in the short–run is
statistically significant at 10% with a negative sign, and again, confirming that a
long-run equilibrium relationship exists between the variables.

The analyses show that the parameter of the ECT in the model is statistically
significant and correctly signed. This confirms that the Malaysia’s Exports to
Singapore has an automatic adjustment mechanism. Error Correction Term (ECT)
Coefficient of -0.58631 suggests that Malaysia’s Exports to Singapore will
converge towards its long run equilibrium level in a moderate speed in-line with
any volatility in Singapore’s GDP or Exchange Rate.

Results of the estimate regression show that the variables are significant in
the long run (based on equation 3.1.1)

The model derived from regression equation is as follows:

LRXSPO = α + 0.8353*LRSPOGDP - 0.7341*LRRMUSD + εt , R2 = 0.975

From this model, 97.5% of total variation of Malaysia’s Exports to Singapore


(LRXSPO) can be explained by the linear model with real Singapore’s GDP
(LRSPOGDP) and Exchange Rate (LRRMUSD) as independent variables.

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From the model, LRSPOGDP has positive impact on Malaysia’s Exports to
Singapore. An increase of 1 % of Singapore’s GDP is expected to increase
0.8353 % of Malaysia’s Exports to Singapore (ceteris paribus). Exchange Rate
has negative impact on Malaysia’s Exports to Singapore. An increase of 1% in
the Exchange Rate (RM-USD) is expected to reduce 0.7341% of Malaysia’s
Exports to Singapore (ceteris paribus). In other words, when RM appreciates
against USD there is expected reduction in Malaysia Exports to Singapore (since
Malaysian goods become more expensive).

Based on VECM, the cointegrated model derived from that approach is as


follows:

ΔLRXSPO = α + 0.50998*ΔLRXSPO(-3) -0.975592ΔLRSPOGDP(-3)


+1.465882*ΔLRRMUSD(-3) - 0.58631*ECT(-1)
The overall model is significant at 99% confidence level.

Based on causal Granger analysis, Singapore’s GDP and Exchange Rate have
one direction Causal Granger relationship to Malaysia Exports to Singapore.
However, both Singapore’s GDP and Exchange Rate have bi-directional causal
Granger relationship between them.

Areas for Improvement

Treatment of Data
Since Singapore’s GDP was effected by the Asian Financial crisis (1997-1998)
and the Global Economic crisis in 2008 (sub-prime), the crises could have cause
significant impact to the VECM model. Therefore, if these crises were represented
accordingly in the model (in the forms of proxies or dummy variables), it could
cause an improvement in the VECM model.

Similarly, the impact of Exchange Rate regime could influence the VECM model
as a result of daily changes and fluctuations in the Exchange Rate; and

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misalignment of Exchange Rate (due to government policies & strategies to
influence free trade market) and the fixed rate (currency pegging) such as,
intervention by Government of Malaysia to peg 1USD = RM3.80 during financial
crisis). Further, other external factors such as Iraq wars, SARS, Tsunami, Euro
meltdown, etc could have cause some impact to the model. We believe the model
could be improved further if these elements are addressed accordingly and the
data being handled appropriately.

6.0 REFERENCES

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run and Long-run Irish Export Function: Does Exchange Rate Volatility Matter?,
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Halicioglu, F., 2007, The J-Curve Dynamics of Turkish Bilateral Trade: A


Cointegration Approach, Journal of Economic Studies, Vol.34 No. 2, 2007,
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Osman, H., Hafiez, A.A., and Ramayah, T., 2009, Exports to Arab-Speaking
Countries: Determinants of The Performance of Malaysia Companies,
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Rey, S., 2006, Effective Exchange Rate Volatility on Exports to EU, Journal of
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Sukar, A.H., 1999. US Exports and Time-Varying Volatility of Real Exchange


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The Global Enabling Trade Report 2010, World Economic Forum,


http://www.weforum.org/en/initiatives/gcp/GlobalEnablingTradeReport/index.htm

Yusoff, M., (2005), Malaysia Bilateral Trade Relations and Economic Growth,
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Yusuf, M. (2009), Bilateral Trade Balance, Exchange Rate and Income:


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Press.

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The Central Bank of Malaysia, www.bnm.gov.my

Department of Statistic, Malaysia. www.statistics.gov.my


International Financial Statistic, World Economic Database, www.imf.org

Prof. Mansor, 2010., Class Notes for DBA,IIUM, Gombak, Selangor.

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