Relationship between Crude oil price and Rupee, Dollar
Exchange Rate: An Analysis of Preliminary Evidence
Dr.A.Hidhayathulla1 & Mahammad Rafee.B
2
1Associate Professor of Economics, Jamal Mohamed
College, Tiruchirappalli, India
2Research Scholar (Ph.D MANF JRF), Jamal Mohamed
College, Tiruchirappalli, India
Abstract:
The objective of this paper is to
examine the effects of oil price shocks on exchange rate of Indian rupee
against US dollar using time series data from 1972-73 to 2012-13. Multiple
linear regression models are used to analyse the data. The model result
suggests that the import of crude oil continues to rise up when the crude oil
future prices increases. The oil imports thus became a substantial source of
demand for dollar in India’s foreign exchange market. This strong demand
contributes to strengthen the dollar against Indian rupee, among the other
factors. This finding will contribute to Indian government in making policy to
control the petrol price to avoid rupee depreciation against US dollar.
Key Words:
Oil price shocks, Exchange rate, Imports
of crude oil, multiple linear regression.
- Introduction
India is the 7th largest country with
the land mass of 3.29 million square.k.m. and second largest in population of
over 1.2 billion. It accounts for 17.2 percent of the world population. The
country has to produce about one trillion worth of GDP to fulfill the needs of
its huge population. In order to produce this one trillion dollar worth of
output, India needs 2.5 million barrels of oil per day. This is 4.4 percent of
total world demand for oil. The growth rate of demand for oil is around 6.8 %
(FICCI Report 2012). This ever growing demand exerts profound influence on the
growth and inflation levels in India. International oil price assumed to affect
the domestic prices. However in India’s case the sharp increase in
international oil prices has not been fully transmitted in to the domestic
prices. The administrated price mechanism had shielded the country from the
impact of oil shocks. The government of India has given up the administrated
price mechanism in oil sector and linked the domestic oil prices with
international oil prices. Oil price as external factor certainly affects the
Indian economy, especially the Indian currency where US dollar is the
acceptable currency in International market, thus it became the problem of
research investigation. The impact has been assumed with regard to exchange
rate of rupee to dollar alone. So the impact assessment would be partial,
because oil prices can penetrate into other macro economic variables and all
the sectors of the economy. The public sector oil companies and consumers have
shared the burden of oil price increase in the form of increased prices
(inflation). Public sector companies are backed by budget support of the
government. Recently it has deregulated all petroleum products except LPG
Cylinder and Kerosene (subsidized by Government of India) and ultimate burden
is shifted to people in the form of taxes. Since Energy is the driver of
economic growth. Energy from the oil is the largest source of energy supply.
Payment to oil eats up substantial portion of foreign exchange of oil consuming
countries. India’s oil import bill is
around 30 percent of her total imports. India’s crude oil import bill has
jumped by 9.5% to ₹ 3,47,432 crores in the first five months of
2013, India depends on imports to meet 80 percent of the needs, and imported 81.499 (Million Tonnes) crude oil during the April-August period, up
8.82 percent from 74.892 Mt in the same period a year ago according to
Petroleum Ministry of India.(Business Line September 23, 2013) Many counties
like USA, Malaysia are able to keep stable retail price of oil while many
developing countries like India are having volatile retail price of oil. Of the various sensitive issues that can make or break a government in
India, petrol pricing is one. As on 10 Dec ’12, petrol price in India is ₹ 72.3 (Average price of Metros). If we take Delhi as a base, it has
fluctuated 30 times over the past 4 years causing an increase by 47%. On May
23, 2012 petrol saw its steepest hike ever- by ₹7.54 leading
to nationwide protests by the opposition and the general public. Petrol prices
account for 1.09% weightage of overall WPI (Wholesale Price Index). This
implies that an 11.5% increase (due to the hike of ₹7.54) increases the inflation by 13-15 bps. Inflation, as we
know, reduces the purchasing power of the Rupee and effectively makes people
poorer. In a country where 77 per cent of the population spend 60-80 per cent
of their meager ₹600 monthly income on food (according to the Report of the National
Commission for Enterprises in the Unorganized Sector), the price of petrol is
out of reach of the poorer majority who cannot afford the costs of private
transport.
Therefore, the study that addresses the nuances of consequences of oil price
hike and its relationship with exchange rate of rupee against US dollar assumes
significance.The
paper is further divided into four sections. The second section comprises of
review of literature on crude prices and exchange rate. The third section
devoted to data and methodology and empirical results. The fourth section is offers concluding
comments.
- An
Overview Of Literature On Oil Price And Exchange Rate Relationship:-
Ibrahim
Tuhran and et.al (2012) examined the dynamic relationship between oil
prices and exchange rate of selected emerging economies. It contributes to the
literature in at least three points, first contrary use of general use of
developed economies, the author opted emerging markets to study the
relationship between oil prices and exchange rates. Second , un-parallel to the
literature using monetary models to explore the exchange rates with low
frequency data, oil taken as alternative asset class and use daily oil price
data to investigate the dynamics of exchange rate of an emerging market. Third,
this paper shows how this relation has changed by comparing the relationship
before and after the financial crisis. The study used exchange rates of 13
emerging countries during 2003-10.The study used 5 day week daily time series
data for the period 01-03-2003 to 06-02-2010. Dated Brent Oil price and the US
dollar and the US dollar price of JPMorgan emerging market bond index plus
(EMBI+) Countries exchange rates are sourced from Bloomberg. The study employed
three different unit root tests for each returns and each time frame
separately. Although the unit root rests sometimes yield contradictory results,
the results indicate that in all time frames all exchange rates returns and oil
returns are stationary in levels. The results show that an increased importance
of oil price movements after the financial crisis, as oil prices rise there is
an apparent depreciation of the local currency against the US dollar and the
co-movements has increased during the study period. There are number of reasons
why this co-movement is getting stronger. One reason is that emerging economies
have recovered more quickly than developed countries from the crisis .Increasing
oil prices create a positive sentiment to emerging economies as they are
expected to grow faster than the developed economies.
Mohammad
Shaidan Shaari and et.al (2012) studied the
effects of oil price shock on inflation in Malaysia using monthly data from
2005 to 2011.The study used world crude oil price index(in Malaysian
Ringgit, RM) consumer price index, CPI (based index value of 100 in year 2005)
and exchange rate (RM per $ 1 US dollar). VAR-VECM and Granger causality model
were employed to analyze the data. The empirical findings show, that the co-
integration between all variables are exist at 5% significant level in the long
run. But in the short run only oil crude price affected the inflation. From
Granger causality test, it is found that inflation does not granger cause to
the exchange rate but it does granger cause to the oil price. The oil price
does granger cause to the inflation but it does not granger cause to the
exchange rate. The exchange rate does not granger cause to both of the
variables (inflation and oil prices). So, the change in crude price changes the
inflation. This finding will contribute to Malaysian government in making
policy to control the petrol price to avoid from the inflation.
Ademola
Ojebiyi and David Olugbenga Wilson (2011) analysed “Exchange rate
volatility: an analysis of the relationship between the Nigerian Naira, oil
prices and US dollar”. The model results show that there is a weak/negative
relationship between exchange rate and oil price as there are other factors
that bring about changes in oil price other than the exchange rate. The
activities of cartel pricing policy and oil speculators too have come to
greatly affect the price of crude oil. The results convey that there are other
factors that affect the change in oil price apart from the exchange rate. Crude
oil price change is usually very sensitive to events around the world and
tensions in the oil producing nations. OPEC too affects the price of crude oil
by increasing or decreasing the allocations to be sold by the countries.
Syed
Abul Basher and et.al (2010) investigated
the dynamic relationship between real oil prices, exchange rate index for major
currencies, emerging market stock prices, interest rates, global real economic
activity and oil supply. The results of this paper support to some extent that
oil prices respond to movements in exchange rates. Further, the result reported
in the paper offered some support for higher oil prices affecting exchange
rates in the short run. In particular positive oil shock leads to immediate
drop in the trade weighted exchange rate. On the other hand oil prices respond
negatively to an unexpected increase in oil supply and oil prices respond
positively to an unexpected increase in demand. These results are consistent
with the prediction from a demand and supply model for the oil market oil
prices respond positively to positive shock to emerging stock markets, while
oil prices respond negatively to the positive shock. These results are
important in establishing that in addition to global supply and demand
conditions for oil, oil prices also respond to emerging economy equity markets
and global capital markets.
Mukhriz
Izraf Azman Aziz (2009) estimated the long run effect of oil price and real
interest rate differential on real exchange rate for a monthly panel of 8
countries from 1980 to 2008. Data are sourced from International Financial Statistics
(IFS) published by IMF. Real exchange rate is constructed by using domestic
price level and price level in a foreign country. Real exchange rate is equal
to nominal exchange rate (foreign price level/domestic price level). Real oil
prices are defined as the price of Dubai crude oil expressed in US dollar. The
panel tests are based on within dimension approach (that is panel co-integration
statistic) like v-statistic, panel p-statistic, panel Ipp-statistic and panel
ADF-statistic. The paper has found evidence of non-stationarity for the three
series for all groups of countries. For real oil price and real exchange rate,
the series contain unit root as all panel unit root tests fail to reject the
null hypothesis of unit root at 1% level of significance. For real interest
rate differential, it appears to be weekly non-stationary especially for oil
exporting countries and panel of eight countries as the null hypothesis of unit
root can only be rejected at 10% significance level most unit root tests. The
paper has shown evidence of long-term relation between the three series, and of
causality running from real oil price to the real exchange rate.
- Data
And Methodology:-
The data on oil
prices were downloaded from knomea.com. Data relating to exchange rate and
imports of Crude oil was downloaded from RBI Publication (Hand book of Indian Statistics
2012-13). The study employs an empirical analysis and only focuses on three
chosen variables. The variables that we use are the world crude oil prices in
US Dollars, imports of crude oil in million tonnes by India and exchange rate
of rupee per $1 US Dollar. Time series data from 1972-73 to 2012-13 are used
for all the variables. Two separate model equation are constructed to examine
the relationships. The relationship between import of crude oil and future
price of crude oil is examined using the following equation.
OIt =β0 + β1
OPt + U………… (1)
Where
OPt = Crude oil prices (West
Texas Intermediate Future price per barrel) for the time period t
OIt = Oil Imports (in million
tonnes) for the time period t
In order to analyse the relationship
between exchange rate of Indian rupee Vs dollar and import of crude oil the
following model is constructed.
₹$
X ratet = β0
+ β1 OIt + U………… (2)
₹$ X ratet = Exchange rate of
Indian Rupee against Us Dollar for time period t
OIt = Oil Imports (in million
tonnes) for the time period t
The
oil marketing companies (OMC’s) purchase crude oil by buying the futures
contract and taking delivery. Therefore the futures price is chosen as
explanatory variable. However it doesn’t directly affect the exchange rate of
India. The exchange rate is influenced by crude oil imports. Therefore two
separate model equations are used to analyse the relationship.
3.1. EMPIRICAL
RESULTS: -
Investment decisions of oil derivative
investors determine the futures prices of oil. They speculate price changes and
take investment decisions. The financial market decisions drive the real market
prices. The model result suggests that the import of crude oil continues to
rise up when the crude oil future price increases. The oil imports thus became
a substantial source of demand for dollar in India’s foreign exchange market.
This strong demand contributes to strengthen the dollar against Indian rupee,
among the other factors. The estimated model equation shows that along with one
dollar increase in futures price of crude oil the imports of crude oil of India
raises up by 1.703 Million tonnes. The Second equation shows that every one
million tonnes of crude oil import strengthens US dollar by 0.266 against
Indian rupee.
Table No.1
Dependent variable
|
Independent variable
|
R2
|
β0
Constant
|
β1
Value
|
Significance
|
F
|
T
|
|
I
|
Oil imports (OI)
|
Oil prices (OP)
|
0.773
|
0.810
|
1.703
|
0.000
|
133.033
|
11.534
|
II
|
Exchange rate(₹$ X rate)
|
Oil imports (OI)
|
0.681
|
13.021
|
0.266
|
0.000
|
83.245
|
9.124
|
- Conclusion:-
This paper examined the effects of oil
price shocks on exchange rate of Indian rupee against dollar using time series
data from 1972-73 to 2012-13. Oil price
and imports are rising continuously. This pushes up the demand for dollar which
strengthens the dollar against rupee and Indian rupee is continuously
depreciating. This erodes purchasing power of Indian currency in the
international market. The domestic oil supply augmentation and control over oil
demand seems to be viable policy option to overcome exchange rate depreciation
and its consequences.
References:
[1].
Ibrahim
Tuhran and et.al (2012) “oil prices and emerging market exchange rates”,
Central Bank of republic of Turkey, Middle East Technical University-MPRA Paper
No: 36477, Feb 2012.
[2].
Mohd.Shaidan
shaari and et.al (2012) “the effects of oil price shocks and exchange rate
volatility on inflation: Evidence from Malaysia”. International Business
Research: Vol. 5, No. 9; 2012.
[3].
Ademola
ojebiyi and David olugbenga Wilson (2011) “Exchange rate volatility: an
analysis of the relationship between the Nigerian Naira, oil prices and US
dollar- Master of International Management, Gotland University, Spring semester
2011.
[4].
Syed
Abul Basher and et.al (2010) “oil prices, exchange rates and emerging stock markets”.MRPA
Paper No:30140, April 2011.
[5].
Mukhriz
Izraf azman Aziz (2009) “oil price and exchange rate: a comparative between net
oil exporting and net oil importing countries”. Lancaster University, August
2009.
Online
Sources:
http://www.hindustantimes.com/business-news/Markets/Nation-wide-protests-on-petrol-price-hike-may-delay-diesel-reform/Article1-860727.aspx.
