Malaysia GCC Trade and Financial Linkages: Scope, Opportunities and Potential

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1 Malaysia GCC Trade and Financial Linkages: Scope, Opportunities and Potential Irwan Shah Zainal Abidin 1 and Muhammad Haseeb 2 This study mainly focuses on the bilateral trade between Malaysia and Gulf Cooperation Council (GCC) countries. The Gulf Cooperation Council (GCC) is the largest economic group in the Middle Eastern region and rank seventeenth in the global economy. As part of the trade diversification strategy, Malaysia has strong interest in expanding its trade relations with the Arab Gulf economies. As a member of the Organization of Islamic Cooperation (OIC), trade between Malaysia and the GCC countries is increasing and has led to Malaysia s proposal to expand this relation. Given this background, one of the main aims of this research is to explore in detail bilateral trade relations between Malaysia and the GCC countries and their determinants. In fulfilling this aim, this paper examines Malaysia s trade performance with the Arab Gulf region by analyzing several aspects. The annual time series data from was applied. Based on the findings from fixed effects and random effect all the included variables found significant like per capita GDP, exchange rate and distance. However, overall Malaysia s trade relations with the GCC countries are still insignificant in comparison to that with Malaysia s traditional major trading partners. Nevertheless, due to Malaysia s niche products, expansion strategy of services sectors in both Malaysia and the GCC countries and the existence of favorable countries to exports in the GCC, these may create huge potential for expansion. The findings also reveal that, cultural differences and lack of capital have been the major setback for Malaysian businessmen in doing business with the GCC region. Keywords: Malaysia, GCC, Exports, Fixed Effect, Random Effect 1. Introduction Malaysia has been active in international trade, and is today one of the major trading nations in the world. The Malaysian economy has been highly dependent on externaltrade; in 2016, Malaysia's major trading partners were the United States, Singapore, European Union and Japan. As a dynamic, modern, and well developing Muslim country, Malaysia has been actively promoting trade expansion and enhancement with the Gulf Cooperation Concil (GCC) Countires. 1 Irwan Shah Zainal Abidin, School of Economics, Finance and Banking (SEFB), College of Business (COB), Universiti Utara Malaysia (UUM), Sintok Kedah, Malaysia, irwanshah@uum.edu.my 2 Muhammad Haseeb, School of Economics, Finance and Banking (SEFB), College of Business (COB), Universiti Utara Malaysia (UUM), Sintok Kedah, Malaysia, Scholar-economist@yahoo.co.uk 1

2 In view of this fact, Malaysia has been actively promoting intra-oic to achieve this target by implementing different strategy. One of them is by expanding trade relation with the Middle Eastern countries. Within the Organisation of Islamic Conference (OIC) countries, Gulf Cooperation Council (GCC), which considered as prosperous countries in the Middle Eastern region, has been an active trading partner for Malaysia since 1990s. In the mean time, both Malaysia and GCC countries represent modern, dynamic, and become an example as developed Muslim countries in the world. It is also now national policy to increase Malaysia s exports to the West Asian markets (BNM, 2010, NEAC, 2010a). Under the Malaysian New Economic Model (NEM) which was launched in March 2010, Malaysia is now implementing new approach to its international trade strategy by shifting from production based economy to service based economy. There are several bilteral trade agreements between Malaysia and GCC countries atr took place; such as Agreement on Economic, Commercial, Investment and Technical Cooperation (FAECITC) is a bilateral agreement between Malaysia and the GCC group comprising six countries i.e. United Arab Emirates, Qatar, Oman, Saudi Arabia, Bahrain and Kuwait. The FAECITC is viewed as a step to further strengthen economic relations, improve business environment, increase bilateral trade through the removal or reduction of import duties and legal commitment expected from a Free Trade Agreement (FTA) with the GCC. The scope of the agreement covers: Economic and commercial cooperation; Investment; Technical cooperation; and Exchange of information and expertise. The signing of the FAECITC offers Malaysia several advantages. The GCC, with a total population of 38 million, with a Gross Domestic Product of USD billion in 2016 is an attractive market for Malaysian exports. Currently, Malaysia's exports to the GCC countries totaled USD5.0 billion (RM15.4 billion) for the period January-November Other advantages are : Providing more concrete business environment for investment and trade opportunities; Enhancing exchange of information on foreign trade; Encouraging business communication, particularly between institutions and organisations concerned with foreign trade; Facilitating training and technology transfer; and Providing avenue for both sides to take appropriate arrangements for encouraging capital flows between them. For trade in goods, Malaysia's potential exports to the GCC would include: Halal food and non-food products; building materials; 2

3 electronic and electrical products; chemicals and chemical products; palm oil; machinery & equipment; transportation equipment; rubber products; wooden panels and wooden furniture; and petroleum products. For trade in services and investment, the following are potential areas: Islamic finance; education; healthcare; facility management; ICT; telecommunications, power and water supply and services; infrastructure such as highways, bridges, airports and public amenities; and real estate construction and development. Given the fact that Malaysia is in the process of setting up the Islamic Financial-Hub and World Halal-Hub, Middle-Eastern countries especially Gulf countries are seen as potential partners for trade exchange. At the same time, several GCC financial institutions have been established in Malaysia over the last two years which have created more opportunities for both GCC and Malaysian companies to run their business in the region. Since Malaysia and the GCC have strong indigenous factors that encourage them to enhance their trade relations, this study is the first attempt to discuss the evolution of trade relationships between them. As they are all Muslim countries and part of the OIC, this study allies itself with the contribution to international studies involving Arab and Muslim countries. Furthermore, it is hoped that this study will inspire further research in relation to the issue of international trade, especially with regard to the developing nations. The design of this study is devised as follows: Section 2 handles with a literature review on the relationship between Malaysia s exports and GCC countries. Section 3 discusses the data description and empirical methodology used. Estimation and interpretation of the results are presented in Section 4. Finally, conclusion of the study reported in Section 5. Under the Malaysian New Economic Model (NEM) which was launched in March 2010, Malaysia is now implementing new approach to its international trade strategy by shifting from dependency on traditional exports market (US, Japan and EU) to Asian and Middle East orientation. Malaysia has progressed from an economy dependent on 3

4 agriculture to a manufacturing based, exports-driven economy. Currently, exports relations between Malaysian and West Asian markets, especially the Gulf Cooperation Council (GCC) countries, are currently relatively limited. During Malaysia s total exports billion$ was recorded, where only billion$(2.14 percent) exports to the GCC countries (DOTS, 2016). Malaysian exports to GCC countries was billion$ (0.94 percent) in 1980 which increase till 3.04 billion$ in The detail exports data is presented in Table 1.1. Nevertheless, Malaysia s exports growth to the West Asian market in 2015 was 35 percent which considerably high (BNM, 2015). Given the fact that Malaysia is in the process of setting up the Islamic Financial-Hub and World Halal-Hub, Middle-Eastern countries especially Gulf countries are seen as potential partners for trade exchange. At the same time, several GCC financial institutions have been established in Malaysia over the last two years which have created more opportunities for both GCC and Malaysian companies to run their business in the region. Furthermore, the GCC policy, which is termed look to the east (Ab Rahman & Abu-Hussin, 2009), brings a good opportunity to the far eastern economies and in particular Malaysia. Besides that, exports activity offers the best prospect for both parties to expand their growth. Table1.1: Malaysian Exports to GCC Countries from Years Bahrain Kuwait Oman Qatar Saudi UAE Total World , , , ,

5 1999 1, , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , Total 3,474. 2,959. 3, , , ,114. 1, Note: Malaysian exports with GCC countries like Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, UAE are calculated in million $. Where Malaysian total exports are calculated in billions$. 5

6 2. Literature Review Proceedings of 44th International Business Research Conference 2.1 Theoretical Review Trade between countries occurs by exchanging goods and/or services with their counterparts. Economic interaction between parts of the world has expanded over the centuries and exerted a significant impact on the world s economic development. There is a large volume of published studies describing the theory of international trade which have exemplified to the way that countries interact with each other in exchanging their goods and services. These include classical, neo-classical and new trade discourses (Postigo, 2016). Discussion on international trade started with the maxim of the mercantilists in the seventeenth and eighteenth centuries who believed that to be a rich country, a nation must export more of its products than import them. For them it is necessary to have trade surplus by exporting more products. This surplus then would be settled by an inflow of bullion, or precious metals, primarily gold and silver. They also suggested that governments should impose strict controls on all economic activity including trade between nations (Kalbasi, 1995). As a reaction to the mercantilists views on trade and the role of government(van Marrewijk & Van Marrewijk, 2002), Smith (1776), a founding father of classical economics, issued a free-trade theory based on the Theory of Absolute Advantage (also known as absolute cost). Understanding this view and flow of trade theory are important in order to construct the reason why nations trade with their counterparts. In Smith s influential masterpiece ' An Inquiry into the Nature and Causes of the Wealth of Nations, it is mentioned that: According to Smith (1776), trade between two nations occurs when each country has an absolute advantage. By this, it is meant that, when one nation is more efficient than (or has an absolute advantage over) another in producing one commodity but is less efficient than another in producing a second commodity, then both countries can specialize on their advantage and exchange part of their output with that of the other nation for the commodity of its absolute advantage. In addition, as to the Smith s notion on the specialization in economy, in his argument on international trade there have been nothing more than the application of specialization and the division of labour on a global scale (Fröbel, Heinrichs, & Kreye, 1981). All in all, Smith s argument on absolute cost advantage is that, a country will produce goods or service of it has more efficiency in producing those particulars goods or services than other nations. Nevertheless, Smith s notion on absolute advantage was criticized. As argued by Kennedy, What if there is nothing you can produce more cheaply or efficiently than anywhere else, except by constantly cutting labour costs? (Van Marrewijk & Van Marrewijk, 2002). This means that it is impossible for a country to have absolute advantage over its counterpart, especially in the current modern globalized world. On the other way around, if a country has absolute advantage in all production of goods than its partner, it is possible to trade with the counterparts 6

7 (Brander & Spencer, 1985).There are some other theories also which have discussed the trade relationships such as Ricardo (1817), Heckscher-Ohlin model presented by Heckscher (1919). 2.2 Empirical Literature Since this study contributes to Muslim countries trade and economic relationships, it is important here to discuss literature reviews on the subject and a review of trade and economic relations among Muslim countries. Although the effect of religion on trade is arguable, study conducted by Helble (2007) by using secondary data and employing gravity model, he estimated the different impacts of religious belief on trade. He came to conclusion that religious openness has strong positive effect on trade. Therefore, it is an aspiration of OIC to strengthen the intra-oic trade within the Muslim countries context. There have been a number of empirical studies related to the international trade which have reflected various points of view, especially studies on the bilateral trade activities between countries. However, to date, there has been no academic study or project focusing on the bilateral trade flow between Malaysia and the Middle Eastern countries, specifically those of the GCC. Nevertheless, Idris (2006) conducted a study which focused on political relations between Malaysia with the individual GCC countries. He analyzed Malaysia s relation with Saudi Arabia under the small s state relationship framework theory. He has contributed significantly in understanding key determining factors that influence Malaysia Saudi Arabia relations. According to him, there are four key determining factors that shape Malaysia Saudi relations: the nature of state and regime interest, economic determinants, religious affiliation, and membership of small state organizations. These factors, however, do not necessarily signify closeness in relations. Up to now, there has been no study focusing on Malaysia and the Gulf region in terms of economic or trade relations. Since Malaysia and the GCC countries are both OIC members, it is important to discuss this issue within the Muslim country s context. 3. Methodology The extended model of the exports is developed and has been examined empirically for the case of Malaysia using data on bilateral trade between Malaysia and GCC countries during the Bilateral panel data of GCC countries (Saudi Arabia, Qatar, Bahrain, Oman, Kuwait and UAE) are collected from different sources. Trade statistics over the sample period have been collected from Direction of Trade Statistics (DOT) database on the IMF website. The GDP and per-capita GNI data have been collected from World Development Indicator (WDI) database of the World Bank and nominal exchange rate and consumer price indices to calculate RERs have been collected from the International Financial Statistics (IFS) database of the IMF. In measuring exportweighted distance (EWDij), the geographical distance between Kuala Lumpur (the capital city of Malaysia) and the capital cities of respective partner countries are 7

8 obtained from World Bank website ( and have been weighted by the ratio of bilateral exports volume from respective partners to total import volume of Malaysia(Eij) in respective years. All observations are annual and were processed following required procedures. 3.1 Model Specification Taking logarithms and adding time subscripts ( t ) and an error term ( µ it ) to the estimating equation of trade balance becomes: (1) This is the empirical model of this study. It is a generalization of the several types of specification to be used in the empirical analysis based on different estimation techniques of static panel data econometrics. The signs of the estimators associated with the variables in the model are expected to be like traditional theoretical expectations. It is expected that the effects of real exchange rate (RER ji ) and of the import-weighted distance (MWD ij ) on trade balance are negative. The more the real exchange rate (RERji) index drops the more there is a depreciation of the exporter s (country I s ) currency with respected to the increasing export competitiveness (elasticity approach). Import weighted distance, being proxy for transport cost, has negative on the trade balance. The signs of the coefficients of relative GDP (RGDP ji ) and relative per capita GNI (RPGNIji) are ambiguous. The higher relative GDP (RGDPji) implies that country-j (partner country) produces more goods compared with country i (home country) and partner country comparatively has more capacity to meet her domestic demand as well as has more exporting capacity. This implies that the partner country j will export more to and import less from country i. Larger countries have more diversified production and tend to be more self sufficient (Kalbasi, 2001) and therefore, will have negative impact on the bilateral trade balance of small home country i. That is, β 1 is expected to be negative. In other words, an increase in GDP of partner country -j relative to GDP of home country -i(rgdpji=gdpj/gdpi) will see a deterioration in the trade. 3.2 Method of Analysis Before carrying out panel data estimations, it is necessary to choose the appropriate estimation techniques for the model and test for the characteristics of specification. The likelihood ratio test for individual effects and Hausman test are performed to decide whether individual effects are treated as country-specific or period specific and for such effects choice are made between fixed or random. Tests for heterscedasticity, autocorrelation and multicollinearity assist specification and estimation. The following tests are first carried out to help choose the estimation techniques. 8

9 3.3Test for Individual Effects To test for the presence of individual effects the unrestricted specification of the model in equation must be estimated first using a two-way fixed effects estimator. The joint significance of all of the effects as well as the joint significance of the cross-section effects (here, the country-specific effects) and the period effects are tested separately. Three restricted specifications have been estimated: one with period fixed effects only, one with cross-section fixed effects only, and one with only a common intercept. All three sets of tests results are presented in Table 3.1. Table 3.1: Redundant Fixed Effects Tests Effects Test Statistics d.f p-value Cross-section F (49,1148) Cross-section Chi-square Period F (25,1148) Period Chi-square Cross-Section/Period F (74,1148) Cross-Section/Period Chi- Square Results show the joint significance of all these tests using sums-of-squares (F-test) and the likelihood function (Chi-square test). The two statistic values and the associated p- values strongly reject the null that the effects are redundant. It indicates the presence of strong individual effects (country-specific effects) in the first case, period effects in the second case and joint significance of all of the effects in the third case. In this study, impacts of the determinants of the model differ between country pairs due to heterogeneous country characteristics. It is of interest to identify the country-specific effects and to explore the possibility of heterogeneity across countries. Since time series variabilityis deemed sufficient to allow reasonably precise estimates, we specify the static model by assuming that the parameters are constant over time and might be variable across countries. Cross-section specific (i.e. country-specific) effects of the model have also been performed and the presence of this type of effect is confirmed by the test result. 3.4 Fixed Effects versus Random Effects The Hausman Test In the estimation, unbalanced panel data have been used, and individual effects are included in the regressions. So, it has to be decided whether they are treated as fixed or as random. A central assumption in random effects estimation is that the random effects are uncorrelated with the explanatory variables. One common method for testing this assumption is to employ the Hausman (1978) test to compare the fixed and random effects estimates of coefficients. Hausman test indicates whether the specific effects are correlated or not with the explanatory variables. 9

10 To perform the Hausman test, first a model with random effects specification has to be estimated. The high value of Hausman Chi-square statistics (that is, low p-value) favour Fixed Effects Modeling and low value of Hausman Chi-square statistics (that is, high P-value) favours Random Effects Modeling. The result of Hausman Test statistics suggests that Fixed Effects Model (FEM) is the appropriate panel data estimator for this study, since the Chisquare statistic (χ2 = 93.47) provides no evidence against the null hypothesis that there is no misspecification. 3.5 Test of Multicollinearity To check whether there is multicollinearity in the model the simple correlation coefficients between the explanatory variables have been examined. The values of all the correlation coefficients between explanatory variables are lower than Following some authors(seddighi, Lawler, & Katos, 2000) it is argued that the test does not detect the existence of severe multicollinearity of explanatory variables of the model. 3.6 Test of Heterscedasticity In panel data analysis homoscedasticity is an underlying assumption. Consequently, the assumption of homoscedasticity in the panel sample data needs to be tested. To test the heterscedasticityin the model the Park Test method has been adopted, which has good power of detecting herteroscedasticity of unknown form. The Park test of model (14) has detected the existence. 4. The Empirical Results The results of individual effect test (likelihood ratio) above suggest use of fixed effect estimation techniques only in the cross-section, i.e. estimating the model including country-specific fixed effects. The Hausman test has suggested that fixed effect of Panel estimation is the appropriate strategy to be adopted. Since no severe multicollinearity is found among the explanatory variables, the model of equation (1) above is estimated taking all variables for all 6 countries for 25 years. The estimation uses White s heteroscedasticity-corrected covariance matrix estimator, which is a robust method. This focused on improving the estimation of the standard errors without changing the estimates of the slope coefficients. In the present model, the intercept terms α0 is considered to be country-specific and the slope coefficients are considered to be the same for all countries. Table4.1 reports the country specific effects (fixed effects) of White s heteroscedasticity corrected model regression result. The coefficient of relative GDP (RGDP) is negative (-2.29) and highly significant (p = 0.000). This implies that, trade balance of Malaysia deteriorates when GDP of partner countries increases relatively more than that of Malaysia. 10

11 Table 4.1: Hetro - Crrected Fixed Effect Model It means partners production and exporting capacity increases at a higher rate than that of Malaysia. In bilateral trade, this usually results in more export to Malaysia or less import from Malaysia, and hence, adversely affects the balance of trade of Malaysia. The coefficient of the relative per capita GNI is positive ( ) and also highly significant as expected. Since the per capita GNI is the determinant of absorption capacity of a country, therefore, higher relative per capita GNI (RPGNI) implies higher absorption capacity of the country. Due to increase in absorption capacity, it is expected that the country imports more. Trading partners of Malaysia with higher RPGNI relatively import more from Malaysia, improving its balance of trade. It justifies the Linder hypothesis in case of Malaysia. The negative sign of the coefficients of real exchange rate (RER) and import-weighted distance (MWD) are as expected. The coefficients are highly significant. The negative sign of the coefficient of real exchange rate (RERij) implies that the more the index of RERij drops the more there is depreciation of Malaysiai Taka (as exporter currency) with respect to the currencies of her trade partners. This will increase the export competitiveness of Malaysia and hence will improve her trade balance (TBij). The import-weighted distance (MWDij) as a proxy for transport cost represents an obstacle (or resistance ) to trade. The significant negative value of the coefficient of MWDij indicates that Malaysia tends to import relatively more from neighbouring countries than to export and results in negative effect on her trade balance. However, the low value of elasticity of transport cost (-0.844), indicates that the trade balance of Malaysia is not very sensitive to transport cost, as 11

12 expected. A 1% increase in transportation cost decreases the bilateral trade balance of Malaysia expressed as ratio of export to import by 0.84%. The reported R-square and F-statistics of the regression output in Appendix A2 are based on the difference between the residuals sums of squares from the estimated model, and sums of the squares from a single constant-only specification, not from a fixed-effect-only specification. As a result, the interpretation of these statistics is that they describe the explanatory power of the entire specification, including the estimated fixed effects reported in Table4.2. TheR-square is and F-statistics is highly significant with p = This implies that including estimated fixed effects, the entire model explains 76 percent of variations in the trade balance. The estimation results of autocorrected error structured model in Table4.3 also support the above analysis though the values of the coefficient are slightly different for the explanatory variables Table: 4.3: Auto correlated Error Structured Fixed Effects 6. Conclusion In an era of globalization and exports a clearer understanding of the factors underlying a country s trade position is needed. The extended international trade model developed in this study captures the effects of all the factors influencing international trade as suggested by conventional elasticity, absorption and monetary approaches and the Gravity Model. In the standard models, absolute factors like domestic GDP, trading partners GDP, domestic per capita income, partners per capita income, distance between trading countries and the real exchange rate between trading partners determine the trade balance. The extended model postulates that relative value of GDP of exporter countries, relative per-capita income, real exchange rate, and exportweighted distance (EWDij) between countries determine the trade pattern and hence 12

13 the exports of a country in bilateral trade with partners. The empirical results provide some useful insights into the international trade of Malaysia. The static panel data analysis explores the cross-country variations as well as the time-invariant countryspecific effects on trade balance with heterogeneous economies and finds significant effects of all relative factors on the trade balance of Malaysia. The robustness check ensures the validity of the new specification. References Ab Rahman, A. B., & Abu-Hussin, M. F. B. (2009). GCC economic integration challenge and opportunity for Malaysian economy. Journal of International Social Research, 2(9). Brander, J. A., & Spencer, B. J. (1985). Export subsidies and international market share rivalry. Journal of International Economics, 18(1), Fröbel, F., Heinrichs, J., & Kreye, O. (1981). The new international division of labour. Cambridge Books. Hausman, J. (1978). Specification tests in econometrics Econometrica 46: Find this article online. Heckscher, E. F. (1919). The effect of foreign trade on the distribution of income. Helble, M. (2007). Is God good for trade? Kyklos, 60(3), Idris, A. (2006). Key determining factors influencing small states' relationships: a case study of Malaysia's relations with Saudi Arabia. Kalbasi, H. (1995). Trade flows and comparative advantage for Iran. Hassan Kalbasi. Postigo, A. (2016). Institutional spillovers from the negotiation and formulation of East Asian free trade agreements: Government-business relations in the policymaking of bilateral free trade agreements. Review of International Political Economy, Ricardo, D. (1817). Principles of Political Taxation and Economy: Harmondsworth, Penguin. Seddighi, H., Lawler, K. A., & Katos, A. V. (2000). Econometrics: a practical approach: Psychology Press. Smith, A. (1776). The Wealth of Nations, Book 1. London, Methuen & Co. Van Marrewijk, C., & Van Marrewijk, C. (2002). International trade and the world economy (Vol. 6): Oxford University Press Oxford. 13