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Effect of oil prices on trade balance: New insights into the cointegration relationship from Pakistan

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  • Hassan, Syeda Anam
  • Zaman, Khalid

Abstract

Global oil price shock waves and continuous trade imbalance have raised serious alarms among the policy makers around the world, because of its aggressive impacts for the net oil‐importing economies. The objective of this study is to investigate the impact of rising oil prices on the trade balance of Pakistan by using ARDL approach. Further, this study explores the causality direction between trade balance and oil price shocks in the context of Pakistan over a period of 1975–2010. The result shows that there is a significant negative relationship among oil prices, exchange rate and trade balance in Pakistan, i.e., if there is 1% increase in oil prices and exchange rate, the trade balance decreases by 0.382% and 0.342% respectively. This infers that oil prices and exchange rate induces trade imbalance in Pakistan. In addition, there is a positive relationship between output gap and trade balance which infers inefficient resource allocation and utilization in production. In the short run, there is a positive relationship among exchange rate, output gap and trade balance in Pakistan which shows that an increase in oil prices increases the net income flow in terms of huge cost payments for imports and increases the trade deficit in an economy. The result of Granger causality indicates that there is a bidirectional causality between oil prices and exchange rate in Pakistan which infers that Pakistan has to invest in alternative energy projects to reduce its dependence on oil imports, while there is a unidirectional causality running from oil prices to trade imbalance. This implies that the high oil prices are more appropriate than output gap because it covered all range cause of trade imbalance. The usage of oil in both forms as a fuel and energy can be substituted by solar energy, hydropower, coal energy, and wind energy and high oil demand can be reduced by the establishment of transport infrastructure. The intense need is to redefine and adopt practical step in energy conservation. Regulations, standards, and targets are important in order to provide direction of efficient level of utilization of oil as a fuel.

Suggested Citation

  • Hassan, Syeda Anam & Zaman, Khalid, 2012. "Effect of oil prices on trade balance: New insights into the cointegration relationship from Pakistan," Economic Modelling, Elsevier, vol. 29(6), pages 2125-2143.
  • Handle: RePEc:eee:ecmode:v:29:y:2012:i:6:p:2125-2143
    DOI: 10.1016/j.econmod.2012.07.006
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    2. Sotoudeh, M-Ali & Worthington, Andrew C., 2016. "Estimating the effects of global oil market shocks on Australian merchandise trade," Economic Analysis and Policy, Elsevier, vol. 50(C), pages 74-84.
    3. Suliman Zakaria S. Abdalla, 2014. "The Impact of Oil Price Fluctuations on the Sudanese Stock Market Performance," Working Papers 887, Economic Research Forum, revised Dec 2014.
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    5. Aviral Kumar Tiwari & Olaolu Richard Olayeni, 2013. "Oil prices and trade balance: A wavelet based analysis for India," Economics Bulletin, AccessEcon, vol. 33(3), pages 2270-2286.
    6. Tiwari, Aviral Kumar & Mutascu, Mihai Ioan & Albulescu, Claudiu Tiberiu, 2013. "The influence of the international oil prices on the real effective exchange rate in Romania in a wavelet transform framework," Energy Economics, Elsevier, vol. 40(C), pages 714-733.
    7. Zied Ftiti & Aviral Tiwari & Ibrahim Fatnassi, 2014. "Oil price and macroeconomy in India – An evolutionary cospectral coherence approach," Working Papers 2014-68, Department of Research, Ipag Business School.
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    Keywords

    Trade balance; Exchange rate; Output gap; Oil prices; Bounds testing approach; Pakistan;

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • P33 - Economic Systems - - Socialist Institutions and Their Transitions - - - International Trade, Finance, Investment, Relations, and Aid

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