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Study examines:do unrequited transfers: Aid & remittances affect real exchange rates (RER)? Nominal exchange rate (NER): units of foreign currency per unit of domestic currency (DC). RER= NER (pd/pf) where pd = dom. price level & pf = world price level Rise in value of DC & ER rate mean the same Dutch disease: RER appreciates with increasing Aid & REM hurting exports competitiveness PNG : outlier with large resources: excluded 2
The term Dutch disease: refers to unintended negative impact of a resource boom on a country s nonresource tradable sector, Term: Rise in the appreciation of the Dutch currency in 1960s: surge in the foreign exchange: Discovery of the North Sea gas fields in the Dutch economy 3
Earnings spent within the economy lead to rise in price of non-tradables: water, electricity, land & services Rise in dom.price level & increase in RER hurting competitiveness of exports Term: Dutch disease is extended to cover impact of unrequited capital transfers on export competitiveness as well. 4
PICs :price takers: prices of traded goods are fixed in world markets. Increase in domestic expenditure results only in rise in prices of non-traded goods Relative price change leads to change in composition of output Output in traded goods sector contracts 5
Two major channels Inflows of aid and remittances are expected to result in a spending effect causing an increase in consumption of tradables and non-tradables Prices of tradables determined outside Relative prices of non-tradables increase Boosting domestic price level. 6
Higher RER both fueling and fueled by a resource movement effect Rising non-tradable prices shift resources from production of tradables to non-tradables These shifts exert upward pressures on wages & production costs, & the overall dom price level Resulting appreciation in RER (= NER(pd/pf) hurts export competitiveness 7
There is also the effect flowing out of consumption-leisure tradeoff Leisure is preferred as remittances rise Reduction in overall supply of labour Growing demand: higher consumption due to remittance: reduction in labour supply: further price increases in non-tradable sector. Rise in pd result in REER appreciation 8
Aid as percent of GDP Year Fiji Samoa Sol. Islands Tonga Vanuatu 1980-1989 (Ave) 3.27 25.52 24.35 23.52 29.97 1990-1999 (Ave) 2.85 10.58 14.64 16.56 20.19 2000-2004 (Ave) 1.95 11.27 17.62 11.10 12.65 2005-2009 (Ave) 1.87 9.56 46.93 9.82 13.27 2010 2.51 23.12 68.57 18.45 11.80 2011 2.15 13.91 50.47 20.59 13.82 2012 2.80 15.73 32.74 16.68 16.02 2013 2.22 15.49 27.42 18.28 11.40 2014 2.12 11.96 18.05 18.20 12.07 9
Table 2: PICs: Remittances (percent of GDP): 1980-2015 Year Fiji Samoa Sol Is. Tonga Vanuatu 1980-1989 (Ave) 1.66 25.09 NA 23.14 6.63 1990-1999 (Ave) 1.55 21.83 0.49 18.10 7.61 2000-2004 (Ave) 4.95 16.61 1.34 31.15 7.47 2005-2009 (Ave) 5.73 17.93 2.03 27.16 1.37 2010 5.33 21.09 2.13 20.89 1.68 2011 4.25 20.95 1.91 17.84 2.75 2012 4.80 22.10 2.02 25.72 2.82 2013 4.85 20.68 1.95 27.95 2.96 2014 4.65 17.55 1.41 26.29 3.45 10
REER Index ( Base: 2010=100) : 1980-2014 Year Fiji Samoa Sol. Is Tonga Vanuatu 1980-89(Ave) 67.0 109.5 86.7 168.6 107.4 1990-99 (Ave) 83.8 126.8 90.4 89.1 95.9 2000-04 (Ave) 91.5 126.9 99.5 84.8 104.0 2005-09 (Ave) 88.0 109.0 103.3 93.5 104.4 2010 100.0 100.0 100.0 100.0 100.0 2011 96.7 99.1 97.0 106.0 101.5 2012 93.8 97.1 88.8 106.7 102.4 2013 92.9 95.5 82.5 108.1 98.7 2014 93.8 95.5 78.0 103.8 94.6 Source: IMF(except Tonga and Vanuatu); authors' calculations 11
Exports of PICs as (% of GDP) Year Fiji Samoa Sol Is Tonga Vanuatu 1980-89 46.9 NA 34.9 26.3 41.8 1990-99 51.8 29.4 35.4 21.3 44.9 2000-09 56.0 29.2 31.3 15.9 43.0 2010 57.8 29.2 50.0 12.7 46.6 2011 59.3 28.7 61.1 16.8 44.3 2012 61.0 27.7 62.0 19.5 49.1 2013 56.6 30.3 56.4 21.2 47.8 2014 54.8 28.2 NA 17.8 48.0 12
Exports of PICs as % of their imports : 1980-2014 Year Fiji Samoa Sol Is Tonga Vanuatu 1980-1989 62.5 26.6 86.1 15.5 38.3 1990-1999 61.5 10.2 98.2 19.2 36.1 2000-2004 57.0 11.6 74.5 14.3 33.0 2005-2009 41.8 5.6 58.8 6.9 28.7 2010 46.3 4.9 73.8 5.2 26.8 2011 49.0 5.3 86.4 9.0 26.5 2012 54.3 11.1 112.6 8.7 27.0 2013 39.3 7.4 96.5 11.1 27.4 2014 34.1 NA 98.9 10.3 28.2 Source: WDI 13
Testing Aid & Rem positively affect REER Trade weighted REER rate from IMF Data constraint: Min. number of variables. Policy variable: capturing effects of fiscal & monetary policies on REER: domestic credit as ratio of GDP Expansionary policies influence REER No a priory conclusion on direction (+ or -) 14
Domestic Credit by ( % of GDP) :1980-2014 Year Fiji Samoa Sol.Is Tonga Vanuatu 1980-89(Ave) 33.2 15.8 24.5 24.7 23.3 1990-99(Ave) 41.8 5.6 24.4 31.5 32.8 2000-04 (Ave) 79.8 25.5 33.8 40.5 40.6 2005-09 (Ave) 124.3 50.9 34.0 47.7 47.8 2010 132.3 63.9 27.2 40.3 63.7 2011 115.6 62.7 14.1 29.9 67.7 2012 114.4 61.2 11.8 27.0 70.0 2013 111.9 67.2 21.0 28.6 68.7 2014 113.1 77.4 22.2 29.5 72.1 15
Sign of Dom.Credit: positive or negative. If policy measures would lead to rise in supply of non-tradables, there would be fall in domestic inflation That will result in REER. Negative sign On the other hand, if economic policies are inflationary, there would be a rise in REER, given world price level. 16
The model for estimation purposes is written as follows: REER i,t = β 0 + β 1 AID i,t + β 2 REM i,t + β 3 DOMCRE i,t + ε i,t where REER: Real exchange rate in index number; AID = aid as percentage of GDP; REM = remittance inflows as percent of GDP; DOMCRE= domestic credit as percent of GDP; ε i,t = white noise error term. 17
Panel Unit Root and Stationary Tests: Maddala and Wu (1999), Hadri (2000), Levin et al. (2002) and Im et al. (2003) Panel Cointegration Pedroni (1999, 2001, 2004) and Kao (1999) panel cointegration tests. Pedroni (1999, 2001, 2004) considers seven different statistics 18
Panel Fully Modified OLS (FMOLS) Estimates The FMOLS procedure accommodates the heterogeneity that is typically present both in the transitional serial correlation dynamics and in the long run cointegrating relationships. TEST RESULTS ON REQUEST 19
Six out of seven Pedroni statistics: establish cointegration The estimated long run estimated panel equation : REER = 0.194 AID +0.298 REM 0.471 DOMCRE (3.651) (4.232) (-6.096) Variables are in logs 20
Estimated coefficients: elasticities 1% rise in AID results in 0.2% increase in REER. 1% in rise in REM leads to 0.3%rise in REER Expansionary policies result in rise in non-trables supply: fall in REER: 21
A panel study: 5 PIC which have currencies of their own: Fiji, Samoa, Solomon Islands, Tonga and Vanuatu. Many commonalities: A panel study: 1980-2014 Variables: REER in Index; aid & remittances as % of GDP; & policy variable: Domestic credit as % of GDP 22
Finding: Existence of strong evidence in favour of significant & direct association with aid & remittance inflows and appreciation of domestic currency Phenomenon of Dutch disease hurting the attractiveness of its exports operates 23
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Increase output of non-tradables & import substitution wherever possible Focus on dom. production of vegetables, fruits and milk PICs: large areas of arable land unutilized Emphasis should be on lessening domestic inflation. 25
THANK YOU 26
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It was six men of Hindostan To learning much inclined, Who went to see the Elephant (Though all of them were blind), That each by observation Might satisfy his mind.