ANALYSIS OF THE INTERACTION OF EXCHANGE RATE FLUCTUATIONS TOWARDS EXPORTS AND IMPORTS PERFORMANCE IN ASEAN-5 COUNTRIES

ANALISIS INTERAKSI FLUKTUASI MATA UANG TERHADAP KINERJA EKSPOR DAN IMPOR DI NEGARA ASEAN-5

UNDERGRADUATE THESIS

By:

SATRIADJIE SARWO GUMILAR 20120430103

ECONOMICS FACULTY

INTERNATIONAL PROGRAM FOR ISLAMIC ECONOMICS AND FINANCE (IPIEF)

ANALISIS INTERAKSI FLUKTUASI MATA UANG TERHADAP KINERJA EKSPOR DAN IMPOR DI NEGARA ASEAN-5

UNDERGRADUATE THESIS

Submitted as the fulfillment on the requirement for Bachelor degree of Economics at the International Program for Islamic Economics and Finance (IPIEF) Department of Economics, Faculty of Economics University of Muhammadiyah

Yogyakarta

By:

SATRIADJIE SARWO GUMILAR 20120430103

ECONOMICS FACULTY

INTERNATIONAL PROGRAM FOR ISLAMIC ECONOMICS AND FINANCE (IPIEF)

“Berubah atau punah? Kritikan itu hal yang biasa bagi orang yang berpikir.”

— Ali Sadikin

“Every saint has the past, and every sinner has a future.”

—Oscar Wilde

“I learn the most from making my own mistakes.” — David Fincher

“It is better to keep your mouth closed and let people think you are a fool than

to open it and remove all doubt.”

First and foremost, all praises to Allah for the strengths, the patience and His blessing in completing this undergraduate thesis. Peace and blessing of Allah be upon last Prophet Muhammad (Peace Be upon Him).

This undergraduate thesis entitled “Analysis of The Interaction of Exchange Rate Fluctuations towards the Exports and Imports Performance in ASEAN-5 Countries” has been kept on track and seen through to completion with the support and encouragement of numerous people. Therefore, the researcher wants to give special appreciation to the related parties in supporting the accomplishment of this research:

1. The honorable Prof. Dr. Bambang Cipto, M.A., as the Rector of Universitas Muhammadiyah Yogyakarta.

2. Dr. Nano Prawoto, S.E., M.Si., as the Dean of Faculty of Economics. 3. Dr. Masyhudi Muqorobin, S.E., Akt.,M.Ec., as the Director of

International Program for Islamic Economics and Finance in Universitas Muhammadiyah Yogyakarta.

4. Dr. Imamudin Yuliadi, S.E., M.Si., as the Head of Department of Economics in Universitas Muhammadiyah Yogyakarta and as my first supervisor together with Mr. Dimas Bagus Wiranata Kusuma, S.E,. M.Sc as my second supervisor for the advices and the supports.

Mr. Umar, and Mrs. Linda Kusumastuti, S.E.

6. For my parents especially to my mother Neny Irmawati who gave so much effort for my studies. Thank you for all the patients, supports, caring and everything I need. For my father Heru Subiyanto and my only younger sister Mojo Putri Sekar Kedaton. Wish we could reach our dream and keep supporting each other as a family.

7. For my family in SunShine Voice UMY, especially for 15th batch members, and all my brothers and sisters in the organization. I’ve learn so much things from you guys.

8. For all the IPIEF 2012 class members. Fitra, Bima, Puguh, Bayu, Irfan, Ardi, Yusuf, Adini, Fanny, Caca, Dyah, Widhia, Andika, Nurul, Lia, and all the colleague brothers and sisters in IPIEF.

9. For all mates in Yogyakarta, Fauzi, Marilda, Dody, Amel, Sayogi, Ovi, and brother uki, especially for Ageng Cahya, who want to shares all of the emotional feelings, passing through the ups and downs, and thank you for all the supports provided.

SUPERVISORS AGREEMENT PAGE ..……… ii

EXAMINER COMMITTE AGREEMENT PAGE……… iii

DECLARATION PAGE…...……… iv

MOTTO PAGE ………. v

TRIBUTE PAGE ……….. vi

ABSTRACT……….. vii

ACKNOWLEDGEMENT……… viii

TABLE OF CONTENTS……….. x

LIST OF TABLE ……….. xii

LIST OF FIGURE………. xiii

CHAPTER I INTRODUCTION………..……… 1

1.1 Background ...………..…….. 1

1.2 Limitations of Research...………..……… 6

1.3 Research’s Problem ……….……….… 6

1.4 Purposes of Research …..……….….…..…. 7

1.5 Research’sOutline.……… 7

CHAPTER II LITERATURE REVIEW……… 9

2.1 Theory……… 9

2.2 Previous Studies……… 27

2.3 Theoretical Framework………. 29

2.4 Hypothesis……… 32

CHAPTER III RESEARCH METHODOLOGY……….. 33

3.1 Research’s Object ………. 33

3.2 Data Types ..……….... 33

3.3 Technique of Data Collection……….. 34

3.4 Operational Definition of Researched Variables……….. 34

5.1 Conclusion ..……… 75

5.2 Suggestion……… 77

REFERENCES…….………...…………... 78

2.1 Absolute Advantages………. 20

2.2 Comparative Advantages ………..………... 22

2.3 Previous Studies………..……… 27

3.1 Observed Variables…….……….……… 35

4.1 Unit Root Test………. 50

4.2 Optimal Lag Length Criteria ………. 51

4.3 Cointegration Test ………. 52

4.4 Cointegration Test 2……… 53

4.5 Granger Causality Test………...……….. 55

4.6 Short-term VECM Estimation……… 58

4.7 Long-term VECM Estimation………….……… 59

2.2 Research Framework ………..……… 32

3.1 VAR/VECM Analysis Process ……… 41

4.1 Singapore’s Trade Balance……… 44

4.2 Malaysia’s Trade Balance……….…………... 45

4.3 Thailand’s Trade Balance………... 46

4.4 Indonesia’s Trade Balance………...………... 47

4.5 Philippine’s Trade Balance ………... 48

4.6 Singapore IRF (graph) ………... 67

4.7 Malaysia IRF (graph) ……….………... 67

4.8 Thailand IRF (graph) ……….………... 68

4.9 Indonesia IRF (graph) ……… 69

ANALISIS INTERAKSI FLUKTUASI MATA UANG TERHADAP KlNERJA EKSPOR DAN IMPOR DI NEGARA ASEAN-5

By

SATRIADJlE SARWO GUMILAR 20120430055

This Undergraduate thesis has been reviewed and validated before the Examination Committee of the International Program for Islamic Economics and

Finance (IPIEF) Department of Economics, Faculty of Economics University of Muhammadiyah Yogyakarta

August 22od, 2016 The Examination Committee:

Masyhudi Mugarrobin, SE.,M.Ec., Ph.b Chief, Examiner

,..

Co-Examiner

M.Si Agus Tri"Basuki, SE. ,M.Si.

Co-Examiner

Approved by:

Dean of Faculty of Economics, University of Muhammadiyah Yogyakarta

, /

exchange rate and trade balance performance in selected ASEAN-5 countries from 2005 to 2015. It is including the exports, imports, and nominal exchange rate data from each country. This study uses Unit Root Tests, Cointegration techniques, Engle-Granger test, Vector Autoregression (VAR) and Vector Error Correction Model (VECM), impulse-response, and variance decomposition analysis. The findings of this research are: (i) The exports and imports are co-integrated in all selected ASEAN-5 countries. Thus, it implies that all the countries are not in violation in their international budget constrains, and that trade imbalances are short-term phenomena which is sustain in the Long-term. (ii) in impulse-response and variance decomposition analysis, it is indicates that the trade balance variables are not really influence the exchange rate volatility in most of the selected countries.

Keywords: Co-integration, exports, imports, trade balance, exchange rate, VAR/VECM.

CHAPTER I INTRODUCTION

1.1 Background

The South East Asian countries has established the Association of South East Asia Nation (ASEAN) as a regional organization with the aim to increasing regional economic growth. ASEAN was founded in Bangkok Declaration on August 8th, 1967 by five countries i.e. Indonesia, Malaysia, Thailand, Singapore, and Philipine which called as ASEAN-5. ASEAN are become more solid with the establishment of 9th ASEAN summit in Bali on 2003 with the final achievement to declare Bali Concort II to attain full integration of ASEAN countries on 2020 in the ASEAN community forum. The ASEAN community has three main pillars i.e. politic and security cooperation, economic cooperation, and socio-cultural cooperation. Through economic cooperation the ASEAN economic convergence are expected in the form of ASEAN Economic Community (AEC) indicated by the movement of current goods, services, capital and invesment are flowing freely without any restriction. (Pratiwi, 2015)

ASEAN-5 countries principally linked through markets, international trade, financial flows, direct investment and other forms of economic and social exchange. An important indicator for a country’s economic performance is the exchange rate and trade balance stability. Exchange rate as one of the entrances to the economic turmoil that came from outside of the country, while trade balance as the fundamental factors indicating that a country has a strong economic

foundation. According to Mundell-Fleming model rules that for small open economy, if there is incurring exchange rate fluctuations, for instance an exchange rate tends to appreciate, theoretically such condition would hurt export and conversely endorse import. This standard textbook theory and its prescriptions assume that markets are perfect and prices are given by world markets. In macroeconomic view points we can say that export would be more interesting for economic because it will encourage the trading within the country and increasing the value of export based trading. In shortly, the Mundell-Fleming theory taking the assumption that when the exchange rate get fluctuated in such case apreciating, it will decrease the value of export in the country because it will increase the price of goods and services within the country. Conversly, when the nominal exchange rate depreciating it will increasing the value of export, and import value will decrease. (Kusuma, 2010)

As a small open economy, ASEAN-5 economy are fully depended on trade in developing their country. Trade balance stability which came from exports and imports are vulnerable to the economic shocks came from inside and outside of the country. Such an exogenous economic turmoil are easily inhibit the economy development. One of the doorway for exogenous factor is from exchange rate. Therefore, the ASEAN-5 need to oversee their exchange rate fluctuations. Small open economy condition also require the countries under flexible exchange rate regime to applied an interdependent policy. Difference in interest rate level, in such case higher than the neighboring countries would rising up the capital inflows which later will increasing the foreign money, this

condition would drive up the demand for domestic money which later increasing the domestic currency. In order to maintain the currency stable, macroeconomic stability and fundamental factors becomes the focal point and become a very important component for ASEAN-5, especially in the face of global challenges and international competition. Moreover, if there is any exogenous factors that could harm the economy through exchange rate fluctuations. Fundamental economic condition as the indicator that the country can withstand the external economic turmoil has to be in a good performance. However, the characteristic of ASEAN-5 countries has differ one another. Thus, the way they response to the external economic turmoil are different. Table 1.1 shows the ASEAN-5 economic indicators for 2005 and 2014.

Table 1.1

ASEAN-5 Indicators for 2005 and 2014

Country

GDP growth (%)

Private consumption

(%)

Public consumption

(%)

Gross domestic investment

(%)

Inflation rate (%) 2005 2014 2005 2014 2005 2014 2005 2014 2005 2014 Singapore 7.49 2.92 3.41 2.49 5.03 0.05 -0.53 -2.35 0.47 1.02 Malaysia 5.33 5.99 9.11 6.96 6.5 4.4 5.84 2.64 3.03 3.14 Thailand 4.19 0.87 7.99 1.65 14.28 -2.61 12.78 -11.4 4.54 1.9 Indonesia 5.69 5.02 3.95 5.14 6.64 1.98 41.23 4.39 10.46 6.39 Philippines 4.78 6.13 4.42 5.42 2.06 1.74 2.96 5.41 6.6 4.17

Source: Asean Development Bank

In general, ASEAN-5 countries having the economic turmoil in a period of 2005 until 2014. It can be seen from GDP growth, most of all ASEAN-5 decrease except Philippine.

In 2009, the Global Financial Crisis (GFC) reduced demand for exports of Southeast Asian countries, where exports is a major growth driver. Recession in developed countries led to contraction in output of Asian countries through export shortfalls. Expansionary and accommodative monetary policy in response to recession in developed areas, through low interest rates and liquidity injection caused massive capital inflows to Southeast Asia. Consequently, Southeast Asian currencies appreciate substantially and exacerbated export downturn (Bhanupong, 2012).

However, According to Abeysinghe and Yeok, (1998) they argue that the higher the imported input content, the less would be the impact of exchange rate fluctuation on exports. Exchange rate apprectiation considered would have nothing to do with export, whilst, currency depreciation would have some what raise the export. However, the export rising during the period of currency appreciation could be backed up from one of the following possibilities or combinations of them. First, the import content of exports could have been relatively large so that exports were little affected. Second, external demand of goods and services could have been rising as the countries could able to defferentiate the product. Third, the countries could be rising their productivity. Fourth, pricing-to-market policies could have countered the negative effects of currency appreciation.

Irandoust and Ericsson (2004), also found some evident that trade balance imbalancement can predict the exchange rate flctuation. evident to shed light on the policy implications of a long-term relationship between imports and exports.

The relationship can be discerned fromits convergence or econometrically being called as its co-integration which later suggests co-existence of co-integrating vector between exports and imports are implied that a country is not in violation of her international budget constraints and any trade imbalances are only a short-run phenomena so that the equilibrium instituted in the long short-run are sustainable.

In brief, the correlation between exchange rate fluctuations and trade balances are seemingly correlated as the sustainability of trade is indicated by how strong its currency fluctuations precipitated and how far the existence of a productivity gap takes place. The productivity gap would drive up both exchange rate and interest rate abroad. Consequently, for developing countries the export would decrease, and investment as the effect of interest rate will go down as well. Conversely, the import and saving would increase as the influence of exchange rate and interest rate jointly. For additional, the high saving gap would affect to the shortfall of productivity domestically. For an export-oriented countries, the wide saving gap also would affect to the external sector disequilibrium. In short, the final effect of these movements is increasing the amount of debt. (Kusuma, 2010)

The Findings above encourage the author to take a research about the correlation between export and import which are important as the fundamental factors indicating that the country has a strong economic foundation and can withstands the external economic turmoil which came through exchange rate fluctuations. Under above pre-quisite, the author taking the research throught this undergraduate thesiswith the title “Analysis of The Interraction of Exchange

Rate Fluctuations Towards Exports and Imports Performance In ASEAN-5 Countries”.

1.2 Limitations of Research

Since the topic are quitely general. The author want to restrict the research problem that might arised. The research are limited to several point of study,

1. Focus on the trade balance performance and exchange rate of ASEAN-5 namely; Singapore, Malaysia, Thailand, Indonesia, and Philippine. 2. The variables used are exports, imports, and nominal exchange rate. 3. The data used for the research are monthly data spaning from 2005:M1

until 2015:M12.

1.3 Research’s Problems

Shortly, this research have some question remark in respect to search some empirical evidence of the topic, the impact of exchange rate flutuation on the export and import performance in ASEAN-5 countries. The questions are;

1. Does the export and import in ASEAN-5 countries co-integrated? 2. Does the nominal exchange rate fluctuationss have a significant effect

toward the export and import performance and vice versa in ASEAN-5?

1.4 Purposes of Research

As the research questions arised, the aims of this research want to make sure of two things;

1. To analyze the existence of co-integration relationship between exports and imports in ASEAN-5 countries.

2. To analyze if there is bidirectional relationshipbetween exchange rate and trade balance performance.

1.5 Research’s Outline

In order to deepy understanding this undergraduate thesis, the author made this reserach outline so the reader can fully understand this research. Research outline of this undergraduate thesis are devided into several chapters which represented each materials.

Chapter I, Introduction; this chapter describes the general information that the research background, problem formulation, purpose and benefits of the research, the scope of research, time and place of study, research methodology, and systematic research.

Chapter II, Theoretical Framework and Hypothesis; this chapter contains the theory that some excerpts taken from the book, in the form of understanding and definition. This chapter explains the theory that not explained in the background, and also including the basic concepts of the topics, and other definitions associated with the macroeconomics variables.

Chapter III, Research Methodology; This chapter contains the definition of variables that used in this research, data and the source, the methodology of co-integration test analysis and Vector Error Correction Model (VECM).

Chapter IV, Research Findings; this chapter describes the general overview of the research. Finding some empirical evidence from the analytical study. It also contains the result from the analysis of co-integration test and vector error correction model (VECM), the result table and diagram, the analysis of empirical result with the theoretical framework and previous study.

Chapter V, Conclusions; this chapter contains of conclusion from the research, suggestion for the policy maker in Indonesia and suggestion for the next research.

CHAPTER II

LITERATURE REVIEW

2.1 Theory

2.1.1 Exchange Rate

Exchange rate is the price of a countries currency in terms of another countries currency. The exchange rate between two countries is the price at which residents of those countries trade with each other. The exchange rate includes of two component, those are Nominal Exchange Rate and Real Exchange Rate. Nominal Exchange Rate is the relative price of the currencies of two countries. While Real Exchange Rate is the relative price of goods in two countries (Mankiw, 2006).

The exchange rate is the ratio between the prices of the currency of a country with the currency of other countries. For example, rupiah exchange rate against U.S. dollar show how the rupiah needed to be switched with one American dollar. (Musdholifah & Tony, 2007). Exchange rates is the exchange between two different currencies, namely the value or price comparison is between the two currencies. (Triyono, 2008).

Heru (2008) States that exchange rates reflect the balance of supply and demand towards domestic currency foreign currency $US. The exchange rate of rupiah against foreign currencies had a negative influence whatsoever against the economy and stock market. With the depreciation of the exchange rate of

rupiah against foreign currencies will lead to rising costs of imported raw materials to be used for production and also increase the interest rates.

A drop in the currency reflects declining demand of domestic currency because of the declining role of the national economy or because of the growing demand for foreign currency ($US) as means of international payments. Strengthened currency to some extent means describing the performance of money market increasingly showed improvement. As the impact of rising inflation rate then the domestic exchange rate weakened against foreign currencies. This resulted in a decrease in the performance of an enterprise and investment in capital markets be reduced.

To see the relation between the real and nominal exchange rates, consider a single good produced in many countries: cars. Suppose an American car costs $10,000 and a similar Japanese car costs 2,400,000 yen. To compare the prices of the two cars, we must convert them into a common currency. If a dollar is worth 120 yen, then the American car costs 1,200,000 yen. Comparing the price of the American car (1,200,000 yen) and the price of the Japanese car (2,400,000 yen), we conclude that the American car costs one-half of what the Japanese car costs. In other words, at current prices, we can exchange 2 American cars for 1 Japanese car.

� � � ℎ� �� = �120 � �×�10,000

�

� � � � �

�2,400,000_{Japanese car}yen �

= 0,5 �� � �

At these prices and this exchange rate, we obtain one-half of a Japanese car per American car. More generally, we can write this calculation as

� � � ℎ� ��

= � � ℎ� � ×� � �

� � �

The rate at which exchange foreign and domestic goods depends on the prices of the goods in the local currencies and on the rate at which the currencies are exchanged.The real exchange rate between two countries is computed from the nominal exchange rate and the price levels in the two countries. If the real exchange rate is high, foreign goods are relatively cheap, and domestic goods are relatively expensive. If the real exchange rate is low, foreign goods are relatively expensive, and domestic goods are relatively cheap. (Mankiw, 2006).

Real Exchange Rate = Nominal Exchange Rate × Ratio of Price Leve e = e × (P/P*)

This equation shows that the nominal exchange rate depends on the real exchange rate and the price levels in the two countries. Given the value of the real exchange rate, if the domestic price level P rises, then the nominal exchange rate e will fall: because a dollar is worth less, a dollar will buy fewer yen. However, if the Japanese price level P* rises, then the nominal exchange rate will increase: because the yen is worth less, a dollar will buy more yen.If a country has a high rate of inflation relative to the United States, a dollar will buy an increasing amount of the foreign currency over time. If a country has a low rate of inflation relative to the United States, a dollar will buy a decreasing

2.1.2 Exchange Rate Regime

Exchange rate regime refers to the ‘way’ the value of the domestic currency in term of foreign currencies is determined. It is closely related to monetary policy and the two are generally dependent on many of the same factors. Exchange rate regimes can broadly be categorized into two extremes, namely fixed and floating. Exchange rate regimes are typically divided into three broad categories.

At one end of the spectrum are hard exchange rate pegs (Fixed Exchange Rate).These entail either the legally mandated use of another country’s currency (also known as full dollarization) or a legal mandate that requires the central bank to keep foreign assets at least equal to local currency in circulation and bank reserves (also known as a currency board). Panama, which has long used the U.S. dollar, is an example of full dollarization, and Hong Kong SAR operates a currency board. Hard pegs usually go hand in hand with sound fiscal and structural policies and low inflation. They tend to remain in place for a long time, thus providing a higher degree of certainty for pricing international transactions. However, the central bank in a country with a hard exchange rate peg has no independent monetary policy because it has no exchange rate to adjust and its interest rates are tied to those of the anchor-currency country.

In the middle of the spectrum are soft exchange rate pegs (Managed Float) that is, currencies that maintain a stable value against an anchor currency or a composite of currencies. The exchange rate can be pegged to the anchor within a

narrow (+1 or -1 percent) or a wide (up to +30 or –30 percent) range, and in some cases, the peg moves up or down over time, usually depending on differences in inflation rates across countries. Costa Rica, Hungary, and China are examples of this type of peg. Although soft pegs maintain a firm “nominal anchor” (that is, a nominal price or quantity that serves as a target for monetary policy) to settle inflation expectations, they allow for a limited degree of monetary policy flexibility to deal with shocks. However, soft pegs can be vulnerable to financial crises which can lead to a large devaluation or even abandonment of the peg and this type of regime tends not to be long lasting.

At the other end of the spectrum are floating exchange rate regimes. As the name implies, the floating exchange rate is mainly market determined. In countries that allow their exchange rates to float, the central banks intervene (through purchases or sales of foreign currency in exchange for local currency) mostly to limit short-term exchange rate fluctuations. However, in a few countries (for example, New Zealand, Sweden, Iceland, the United States, and those in the euro area), the central banks almost never intervene to manage the exchange rates. Floating regimes offer countries the advantage of maintaining an independent monetary policy. In such countries, the foreign exchange and other financial markets must be deep enough to absorb shocks without large exchange rate changes. Also, financial instruments must be available to hedge the risks posed by a fluctuating exchange rate. Almost all advanced economies have floating regimes, as do most large emerging market countries (Mark, Harald, and Romain, 2008)

A floating exchange rate, by definition results in an equilibrium rate of exchange that will move up and down according to a change in demand and supply forces. The process by which currencies float up and down following a change in demand or change in supply forces is, thus, illustrated in figure 2.1

Assume that national income rises. This results in an increase in the demand for imports of goods and services and, hence, demand for dollar rises. This result in a shift in the demand curve from DD1 to DD2. Consequently, exchange rate rises as from OP to OP1determined by the intersection of new demand curve and supply curve.

2.1.3 Exports

Exports are the goods and services made in one country and transmitted to the other countries by trading. The sale of such goods adds to the producing nation's gross output. If used for trade, exports are exchanged for other products

P

S1

S P1

D D

O

E1 E

D2 D1 M1

M Figure 2.1

or services. Exports are one of the oldest forms of economic transfer, and occur on a large scale between nations that have fewer restrictions on trade, such as tariffs or subsidies.

Exports is selling the domestic product produced by domestic producer to the oversea or out of the state. Out of State means, out of the customs area of the country or out of the jurisdiction of the State (Purba, 1997). Export is the attempt of doing the sales that the country have to deliver the goods or servicesto foreign country in accordance with the provisions of the Government expects payment in foreign currency (Amir, 2004). So the results obtained from the exporting activity is either a value of an amount of money in foreign currency or foreign exchange, which is also one of the sources of revenue of the state. So the export trade activities is stimulating the domestic demand that causes the shockof large factory industries, along with a stable positive structures and efficient social institution (Todaro, 2000).

Export is one of the sectors of the economy that play an important role through the expansion of markets and industrial sectors that will encourage other industrial sector and economy (Meier, 1996:313). In conclusion, export is a source of foreign exchange for market expansion plus the production of domestic goods and the expansion of the labor (Marie Muhammad,

www.fiskal.depkeu.go.id). In Robert Mundell’s theory of open economy state

that the international trade will have a big influence to the trade balance and give an influence to the country if their export are bigger then import (X>M),

through this assumption many states stripped to open their economic and conducting international trade in order to achieves the export expansion.

There are at least three roles of export in the economy;

• Expanding several product to the worldwide market in order to achieves the economic growth, as mantioned by the clasical economic theory which state that, an industry can grow quickly if the industry can sell the results across oceans rather than only in the narrow country market.

• Export creates new effective demand. So, the domestic producers are looking for innovations that are intended to increase productivity. • Expansion of export activities facilitates development, because of the

narrowness of the domestic market due to a low rill income level or the relationship of adequate transportation.

Thus, beside of increasing the domestic production, exports increasing the domestic demand as well. Effective demand which constitute demand with the ability to buy from the people, can effect the welfare of the country. So that the external demand indirectly affect the domestic producers to optimizing their production.

2.1.6.1 Exports Type

According to Mankiw (2010), there are two type of exports, namely; a. Direct Export

Direct export is a way of selling goods or services via an intermediate or exporter located in another country of destination of the

export. Sales made through a distributor and representative of company sales. The benefit, the production is centered in the State of origin and the control of distribution is better. The disadvantage, transport costs are higher for products on a large scale and the presence of trade barriers and protectionism.

b. Indirect Export

Indirect export is a technique where the goods sold through intermediary or exporter country of origin then sold by middlemen. Through the export company's management, and exporting companies. The benefits of concentrated production resources, and do not need to handle export directly. His weaknesses, control over distribution less and knowledge against the operation in other countries are less.

2.1.4 Imports

Import is a good or service brought into one country from another. The word "import" is derived from the word "port," since goods are often shipped via boat to foreign countries. Along with exports, imports form the backbone of international trade; the higher the value of imports entering a country, compared to the value of exports, the more negative that country's balance of trade becomes.

In international trade statistic imports has the negative relationships with trade balance, mports are contrats with the exports. Imports demand are depend on relative price of domestic and foreign goods. The volume and value of imports will be affected by the domestic output and the relative price between

domestic goods and foreign goods. Imports are contrast with exports. We can say that exports is injection to the economics, but imports is vice versa.

= ∆ �_∆

Where is

= Marginal propensity to consume, ∆ = added imports,

∆ = added exports.

Imports are determined by the ability to produce the product that can compete the foreign product. Which mean, the imports value is depend on national income. The highest the national income, the weakest ability to produce the domestic product, which mean the highest country will imports. It will impact to the negative trade balance and national income. The relationship between imports and national income will be explain in this equation.

= +

Where : = Total Exports

= Unaccounted total export = Marginal propensity to import = National income

2.1.5 The Real Exchange Rate and the Trade Balance

Suppose first that the real exchange rate is low. In this case, because domestic goods are relatively cheap, domestic residents will want to purchase fewer imported goods. For the same reason, foreigners will want to buy many of our goods. As a result of both of these actions, the quantity of our net exports demanded will be high. The opposite occurs if the real exchange rate is high. Because domestic goods are expensive relative to foreign goods, domestic residents will want to buy many imported goods, and foreigners will want to buy few of our goods. Therefore, the quantity of our net exports demanded will be low.

We write this relationship between the real exchange rate and net exports as.

= (�)

This equation states that net exports are a function of the real exchange rate. From the explaination above, there are two analysis that explain what factors that determine the real exchange rate. (Mankiw, 2006)

• The real exchange rate is related to net exports. When the real exchange rate is lower, domestic goods are less expensive relative to foreign goods, and net exports are greater.

• The trade balance (net exports) must equal the net capital outflow, which in turn equals saving minus investment. Saving is fixed by the consumption

function and fiscal policy; investment is fixed by the investment function and the world interest rate.

2.1.6 Theories

2.1.6.1 Trade Based on Absolute Advantage: Adam Smith

According to Adam Smith, trade between two nations is based on

absolute advantage. When one nation is more efficient than (or has an

absolute advantage over) another in the production of one commodity but is

less efficient than (or has an absolute disadvantage with respect to) the other

nation in producing a second commodity, then both nations can gain by each specializing in the production of the commodity of its absolute advantage and exchanging part of its output with the other nation for the commodity of its absolute disadvantage. Adam Smith (and the other classical economists who followed him) believed that Free trade would cause world resources to

be utilized most efficiently and would maximize world welfare.

The illustration of absolute advantages theory will be shown below:

Table 2.1 Absolute Advantages

U.S. U.K.

Wheat (bushels/hour) 6 1

Cloth (yards/hour) 4 5

Source: D. Salvatory 11th edition (page 35)

Table 2.1 shows that in the U.S., one hour of labor time produce six wheat and only one in the United Kingdom. On the other hand it shows the one labor time produce five cloth in the United Kingdom but only four in the

United States. Thus, the United States is more efficient than, or has an absolute advantage over, the United Kingdom in the production of wheat, whereas the United Kingdom is more efficient than, or has an absolute advantage over, the United States in the production of cloth. With trade, the United States would specialize in the production of wheat and exchange part of it for British cloth. The opposite is true for the United Kingdom.

If the United States exchanges six bushels of wheat (6W) for six yards of British cloth (6C), the United States gains 2C or saves 1/2 hour or 30 minutes of labor time (since the United States can only exchange 6W for 4C domestically). Similarly, the 6W that the United Kingdom receives from the United States is equivalent to or would require six hours of labor time to produce in the United Kingdom. These same six hours can produce 30C in the United Kingdom (6 hours’ times 5 yards of cloth per hour). By being able to exchange 6C (requiring a little over one hour to produce in the United Kingdom) for 6W with the United States, the United Kingdom gains 24C, or saves almost five labor - hours.(D. Salvatory 11th edition, 2012)

2.1.6.2 Trade Based on Comparative Advantage: David Ricardo

According to the law of comparative advantage, even if one nation is

less efficient than (has an absolute disadvantage with respect to) the other

nation in the production of both commodities, there is still a basis for

mutually beneficial trade. The first nation should specialize in the production

and export of the commodity in which its absolute disadvantage is smaller (this is the commodity of its comparative advantage) and import the

commodity in which its absolute disadvantage is greater (this is the commodity of its comparative disadvantage).

The illustration of comparative advantages will be show below: Table 2.2

Comparative Advantages

U.S. U.K.

Wheat (bushels/hour) 6 1

Cloth (yards/hour) 4 2

Source: D. Salvatory 11th edition (page 37)

The only difference between Tables 2.2 and 2.1 is that the United Kingdom now produces only two yards of cloth per hour instead of five. Thus, the United Kingdom now has an absolute disadvantage in the

production of both wheat and cloth with respect to the United States.

However, since U.K. labor is half as productive in cloth but six times less productive in wheat with respect to the United States, the United Kingdom has a comparative advantage in cloth.

On the other hand, the United States has an absolute advantage in both wheat and cloth with respect to the United Kingdom, but since its absolute advantage is greater in wheat (6:1) than in cloth (4:2), the United States has a comparative advantage in wheat. To summarize, the U.S. absolute advantage is greater in wheat, so its comparative advantage lies in wheat. The United Kingdom’s absolute disadvantage is smaller in cloth, so its comparative advantage lies in cloth. According to the law of comparative advantage, both nations can gain if the United States specializes in the production of wheat and exports some of it in exchange for British cloth. (At

the same time, the United Kingdom is specializing in the production and exporting of cloth.). (D. Salvatory 11th edition, 2012).

2.1.6.3 The Opportunity Cost Theory

In this form, the law of comparative advantage is sometimes referred to as the law of comparative cost. According to the opportunity cost theory, the cost of a commodity is the amount of a second commodity that must be given up to release just enough resources to produce one additional unit of

the first commodity. No assumption is made here that labor is the only factor

of production or that labor is homogeneous. Nor is it assumed that the cost or price of a commodity depends on or can be inferred exclusively from its labor content. Consequently, the nation with the lower opportunity cost in the production of a commodity has a comparative advantage in that commodity (and a comparative disadvantage in the second commodity).(D. Salvatory 11th edition, 2012)

2.1.6.4 Heckscher–Ohlin Theory

The Heckscher–Ohlin theory is based on a number of simplifying assumptions (D. Salvatory 11th edition, 2012):

• There are two nations (Nation 1 and Nation 2), two commodities (commodity X and commodity Y), and two factors of production (labor and capital).

• Both nations use the same technology in production.Both nations have access to and use the same general production techniques. Thus, if factor prices were the same in both nations, producers in both nations would use

exactly the same amount of labor and capital in the production of each commodity. Since factor prices usually differ, producers in each nation will use more of the relatively cheaper factor in the nation to minimize their costs of production.

• Commodity X is labor intensive, and commodity Y is capital intensive in both nations. Commodity X requires relatively more labor to produce than commodity Y in both nations. In a more technical and precise way, this means that the labor–capital ratio (L/K) is higher for commodity X than for commodity Y in both nations at the same relative factor prices. This is equivalent to saying that the capital–labor ratio (K/L) islower for X than for Y. But it does not mean that the K/L ratio for X is the same in Nation 1 and Nation 2, only that K/L is lower for X than for Y in both nations. • Constant returns to scale in the production of both commodities in both

nations. increasing the amount of labor and capital used in the production of any commodity will increase output of that commodity in the same proportion. For example, if Nation 1 increases by 10 percent both the amount of labor and the amount of capital that it uses in the production of commodity X, its output of commodity X will also increase by 10 percent. If it doubles the amount of both labor and capital used, its output of X will also double. The same is true for commodity Y and in Nation 2.

• Incomplete specialization in production in both nations. even with free trade both nations continue to produce both commodities. This implies that neither of the two nations is “very small”.

• Equal tastes in both nations. demand preferences, as reflected in the shape

and location of indifference curves, are identical in both nations. Thus, when relative commodity prices are equal in the two nations (as, for example, with free trade), both nations will consume X and Y in the same proportion.

• Perfect competition in both commodities and factor markets.Producers, consumers, and traders of commodity X and commodity Y in both nations are each too small to affect the price of these commodities. Perfect competition means that all producers, consumers, and owners of factors of production have perfect knowledge of commodity prices and factor earnings in all parts of the nation and in all industries.

• Perfect internal factor mobility but no international factor mobility. Labor and capital are free to move, and indeed do move quickly, from areas and industries of lower earnings to areas and industries of higher earnings until earnings for the same type of labor and capital are the same in all areas, uses, and industries of the nation. On the other hand, there is zero international factor mobility (i.e., no mobility of factors among nations), so that international differences in factor earnings would persist

indefinitely in the absence of international trade.

• No transportation costs, tariffs, or other obstructions to the free flow of

international trade. Specialization in production proceeds until relative (and absolute) commodity prices are the same in both nations with trade. If we allowed for transportation costs and tariffs, specialization would

proceed only until relativecommodity prices differed by no more than the costs of transportation and the tariff on each unit of the commodity traded. • All resources are fully employed in both nations.

• International trade between the two nations is balanced. The total value of each nation’s exports equals the total value of the nation’s imports.

2.2 Previous Studies

The analysis about trade balance stability and exchange rate volatility has conducted by many researchers. Yet, this study still have to be enhance to get better perspective for economic world. Differend area, time release, or different variables may cause a different result. This previous studies are used, as a comaparison and supporting journal for this research.

Table 2.3 Previous Studies

No Title Model Conclusion

1

Kusuma, Dimas. (2010). Analysis The Impact of Exchange Rate Fluctuation

Toward Export And Imports Performance In

The OIC Member Countries. “Economic and

Trade Integration Among OIC Member Countries:

Opportunities and Challenges”.

VAR/VECM

The conclusion shows that there is evidence of long-run co-integrating relationship between variables in all countries, except for Malaysia. And majority of the observed countries, except Malaysia, seem to have no problem with the existence of exchange rate fluctuation.

2

Ng Yuen-Ling and Wai-Mun, Har and Geoi-Mei,

Tan. (2008). Real Exchange Rate and Trade

Balance Relationship: An Empirical Study on Malaysia. International Journal of Business and Management Vol. 3, No. 8.

VECM

The conclusion shows that long run relationship exists between trade balance and exchange rate.

3

Genc, ElifGuneren and Artar, OksanKibritci.

(2014). The Effect of Exchange Rates On Export

And Imports of Emerging Countries. European Scientific Journal edition

vol.10, No.13.

Panel Model

The conclusions shows there is co- integrated relationship between effective exchange rates and exports-imports of emerging countries in the long run.

4

Rahman, Mohammad Zillur. (2011). Existence of

Export-Import Co integration: A Study on Indonesia and Malaysia.

International Business Research Vol. 4, No. 3;

July 2011

VAR

This paper found export and import to have relationship in the long-run for Malaysian economy but similar relationship was not detected in case of Indonesia.

5

Rahutami, Angelina Ika. (2011). Real Exchange

Rate Volatility and International Trade: ASEAN Experience Toward

ASEAN Economic Community.Seminar and Di

scussion Series of Nijmege n School of Management R

adboud University.

ARCH and GARCH

The estimation result shows that the increasing of term of trade will induce the exports value. The income also has positively significant effect on imports value, but the real exchange rate has a negative significant effect.

6

Irandoust, Manuchehr and Ericsson, Johan. (2002). Are Imports And Exports

Cointegrated? An International Comparison.

Metroeconomica 55:1.

Cross-section

The results indicate that there exists a long-run steady-state relationship between imports and exports for most countries in the sample. The policy

implications of our findings are

that the countries are not in violation of their international budget constraints and, more importantly, there is no productivity gap between the domestic economy and the rest of the world, implying a lack of permanent technological shocks to the domestic economy.

7

Ramli, Norimah and M. Podivinsky, Jan.. (2010).

The effects of exchange rate volatility on exports:

Some new evidence for regional ASEAN countries.

ECM

The conclusion are shows that the real bilateral exchange rate volatility has a significant impact on exports for all the countries considered in the sample, and the impact overall is negative except for Indonesia.

8

Husein, Jamal. (2014). Are Exports and Imports Cointegrated? Evidence

From Nine Mena Countries. Applied

Econometrics and International Development

Vol. 14-1 (2014).

ARDL

The findings of co integration between exports and imports for Iran, Israel, Jordan, and Tunisia indicate that these countries are not in violation of their international budget constraint.

9

Konya, Laszlo and Singh, Jai Pal. 2008. Are Indian

Exports And Imports Cointegrated?. Applied

Econometrics and

The result of this research journals found that Indian exports and imports are not co integrated, so macroeconomic policies of India have not been

International Development Vol- 8-2 (2008).

effective to contain the trade imbalance.

10

Perera, Nelson and Varma, Reetu. (2008). An Empirical Analysis of Sustainability of Trade Deficit: Evidence From Sri

Lanka. International Journal of Applied

Econometrics and Quantitative Studies

Vol.5-1 (2008).

ARMA

The empirical findings suggest that the current account (exports and imports) of Sri Lanka is not sustainable (and this violates its intertemporal budget constraint) in the long-run.

Source: References

The previous studies provide the information which is important for the researcher to enrich the empirical study. Based on the previous studies conducting by researcher, most of the literatures are using VAR/VECM analysis, to see the interaction between exchange rate and monetary policies. Due to the same variables, time release, or the research area so the previous studies are used as the comparison and as a resource to conducting this research.

2.3 Theoretical Framework 2.1.1 Trade Balance

Exports and imports are play an integral role in determining the trade balance performance and economic stability of the countries. Exports as the main role of countries international income and imports as the means of countries needs in order to get economic welfare. The relationship between two variables holds significant importance in maintaining the economic stability. According to expenditures method, an economy’s annual GDP is the sum total

of C + I + G + (X – M), where C, I and G represent consumer spending, capital investment and government spending, respectively.

The standart equation of national growth invole the exports minus imports or net exports (X – M). If the countries exports are greater rather than imports, it is called trade surplus. Conversely, if the countries imports are greater than exports, it is called trade deficits or informally called “trade gap”. The positive trade balance contribute to the economic growth. Higher exports mean that higher outputs from domestic producers, it is affect the high needs of labour in order to maintain the high quality product. The high exports also represent an inflow of funds to the country, which affect the costomers expenditures and contributes to economic growth.

Coversely, an unsustainable trade deficit indicates a violation of international budget constraints over time (Babatunde, 2014). The impact of long-term deficits is that the domestic interest will be increase which affect to the high needs of international debt. The final impact of course will affect the welfare of people in the country. In that case, the long-run stability of two variables are vital to economy. The occurance of cointegration relationship between exports and imports suggest that the trade imbalances are only short term and will sustainable in the long term and confirm the existance of an effective macroeconomic policy.

2.1.2 The Effect of Exchange Rate

The inter-relationship between exchange rate and exports, imports variables is quite disconcerting because the feedback loop beween them. The

exchange rate has the influence to the trade balance performance (surplus or deficits), while it is impact to the exchange rate volatility. The theoritical literature of Mundell-Fleming model states that if the domestic currency goes down, it will stimulate the exports and makes the imports more expesive. Coversely, a strong domestic currency will rise up the exports and makes the imports more cheaper.

According to Thorbecke (2011) on his working paper “The Effect of Exchange Rate Changes on Trade in East Asia” found that exports produced within regional production networks depend on exchange rates throughout East Asia. The continuous flow of parts and components within regional production networks also depends on relative exchange rate stability in the region. Labor-intensive exports depend on exchange rates in the exporting country.The findings also indicate that, while the Asian economies cooperated in the regional production and distribution network, they also compete in the export of labour-incentive manufacturing goods. This competition makes individual Asian countries are not allowing their currency appreciated relative to their neighboring currencies.In accordance with this findings, the researcher wants to make sure if the exchange rate really affect the trade balance and vice versa in selected ASEAN-5 countries.

2.4 Hypotesis

Based on theoritical background, previous research, and research framework. This research develops these following hypotesis:

(a). H1: There is co-integration between trade balance variables, namely exports and imports.

(b). H2: There is bidirectional relationships between exchange rate and trade balance variables.

Exchange Rate

Exports

Imports

Figure 2.2 Research Framework

CHAPTER III

RESEARCH METHODOLOGY

3.1 Research’s Object

The research object is taking the macroeconomic perspective and focused on selected ASEAN-5 countries. This research is conducted to describe how the trade balance performance of selected ASEAN-5 countries and exchange rate fluctuations interrect each orther. The data spaning from 2000;M1 until 2015;M12 from selected ASEAN-5 countries i.e. Indonesia, Malaysia, Singpore, Thailand, and Philippine as secondary data collection.

3.1 Data Types

Quantitative research method are employed to capture the aim of this research. Quantitative researchs are best describe to analyze of macroeconomic fenomena, using the numbers and mathematical approaches as evidence to describe the current economic issues. All data are expressed in time series form and then analyze and utilized by unit root and co-integration tests. The data are monthly data collection of 3 variables (export, import, and exchange rate) from January 2000 to December 2015.

This research conducted using secondary data collection. Secondary data are usually obtained from indirect sources of documentation or official archives in form of numbers or mathemathical notes. The data collected from International

Financial Statistic and other sources that provide the time series variables of selected ASEAN-5 countries.

3.2 Techniqueof Data Collection

Since the data are secondary data, which means can be obtained from indirect sources of documentation in several sites, books, and public articles that provided. However, wrong data colletion which can be error in implementing the research would directly impact the result of research later on. So, this stage could be very crucial for the research.

3.3 Operational Definition of Researched Variables

The analysis is conducted using three variables to capture the effect of exchange rate fluctuation towards trade balance performance. Nominal exchange rate in national currency against US dollar (EXR), the amount of exports in million US dollar (EXP), and the amount of imports in million US dollar (IMP) are used to further investigate theirs relationship.In order to deep understanding of variables observed, the definition table will be shown below.

Table 3.1 Observed Variables

No Variables Explanation Source Unit

1 EXR The number of units

of the domestic currency that can purchase a unit of a given foreign currency. International Financial Statistic Countries currency/Million U.S. dollar

2 EXP Export of the

selected countries in U.S. dollar International Financial Statistic Million U.S. dollar 3 IMP Import of the

selected countries in U.S. dollar International Financial Statistic Million U.S. dollar

1. Exchange rate (EXR) is the price of a nation’s currency in terms of another currency. An exchange rate thus has two components, the domestic currency and a foreign currency, and can be quoted either directly or indirectly. In a direct quotation, the price of a unit of foreign currency is expressed in terms of the domestic currency. In an indirect quotation, the price of a unit of domestic currency is expressed in terms of the foreign currency.

2. An export (EXP) is a function of international trade whereby goods produced in one country are shipped to another country for future sale or trade. The sale of such goods adds to the producing nation's gross output. If used for trade, exports are exchanged for other products or services. Exports are one of the oldest forms of economic transfer, and

occur on a large scale between nations that have fewer restrictions on trade, such as tariffs or subsidies.

3. Import (IMP) is a good or service brought into one country from another. Along with exports, imports form the backbone of international trade. The higher the value of imports entering a country, compared to the value of exports, the more negative that country's balance of trade becomes.

3.4 Model Analysis

To investigate more on wheter the selected ASEAN-5 countries are free from trade imbalances and investigate the effect of it as the exchange rate gets fluctuating; so VAR-based approaches are used.

The analysis used on this model is Vector Autoregression (VAR) model as an attempt to examine the dynamic relationships between two (or more) variables. A time series data are needed to investigate the phenomena using VAR approach. According to Enders (1995), an n-equation VAR is an n-variable linear system in which each variable is in turn explained by its own lagged values and past values of the remaining n-1 variables.

There are some reason for the researcher taking this model as the tools to investigate the variables. First, the previous studies imply that the trade balance’s variables are simoustantly co-integrated. We need to treat each variables symmetrically and see the relationship among them. Second, VAR analysis are very comprehence to a single equation approaches for capturing the long-run

dynamic of variables. VAR approach is enabled to do need to differentiate between exsogen and endogen variables, and its ability to capture dynamic movement as one or more variable are reached in respond a movement from other variable (Sim, 1980).

As the variables are treated as endogenous variables, hence we may write as the equation below.

�� =� + ��− + ��− + ��− +� �� =� + ��− + ��− + ��− +� ��= � + ��− + ��− + ��− +�

The expanse definition of the equation can be writen in matrixes form as below.

� ���� ��

�= �

� �

� �+� � �

��− ��− ��−

�+�

� � � � � � �

In addition, if the variable have unit roots, then we can exploit that there may exist co-movement in their behavior and possibilities that they will trend together toward a long run equilibrium state. Then, using the greater representation theorem, we may posit the following testing relationships that constitute a VEC model for exchange rate fluctuation.

We follow the standard procedure of time series analyses by following these procedures:

1. Unit Root Test – Augmented Dickey Fuller and Phillips-Perron Test

2. Correlation Matrix – Johansen-Juselius Cointegration Test 3. Vector Autoregression-based analysis (VAR/VECM) 4. Impulse Response Function

5. Variance Decomposition Test

The further analysis techniques will be explained in the following chapter. 3.5.1 Unit Root Test

Unit root test supposed to figure out the stationary of research data (Thomas, 1997). This undergraduate thesis using the commonly used tool which called Augmented Dickey Fuller (ADF) and Phillips Perron (PP) test.

The ADF test defines the existence of unit root in the research data. The estimation procedure will takes place in the form;

∆ � =� +� �+� �− +��� ∆ �− �

�= +��

Phillips perron testassess the null hypothesis of a unit root in a univariate time series y. All tests use the model;

� =�+��+� �− +��

Where ∆ _� denotes lag difference under variable consideration. M is the number of lags and �_�is the error term. From the equation above comes with this following hypothesis;

=� = 0

The first equation show that the unit roots does exist and the data is not stasioner. The second equation means that there is no unit roots so than the data is stationer. If null hypothesis cannot be rejected and the data are not stationer in the level, therefore we need to go through higher order differentiating process to archieve stationer.

3.5.2 Co-integration Test

For the co-integration test we employ the VAR-based approach of Johansen (1988) and Johansen and Juselius (JJ, 1990). The latter develop two test statistic to determine the number of co-integrating vector i.e. trace statistic and maximum eighen value test. Start with a VAR representation of the variables, in this case what we think is the economic system we would like to investigate. We have dimensional process, integrated of order d, {x} t∼I (d), with the VAR representation,

��( )��= � +Ψ �+��

The empirical VAR is formulated with lags and dummy variables so that the residuals become a white noise process. Here we do test for all components in the residual process. The reason being that the critical values are determined conditionally on a normal distribution of the residual process. Typically, we will assume that the system is integrated of order one. If there are signs of I(2) variables, we will transform them to I(1) before setting up the VAR. The VAR in levels can be transformed to a vector error correction model (VECM). VECM is utilized to identify the long run behavior of the variables and their short run

relations and therefore can better reflect the relationship among the variables.In a traditional VAR analysis, Luthepohl and Reimers (1992) showed that impulse-responses and variance decomposition analysis can be used to obtain information concerning the interactions among variables.

3.5.3 Vector Auto Regression / Vector Error Correction Model

a. Vector Auto Regression (VAR) is an econometric model used to capture the evolution and the interdependencies between multiple time series. All the variables in VAR are treated symmetrically by involving each variable an equation explaining its evolution based on its own lags and the lags of all the other variables in the model. Econometric model that builds upon the relationship between the variable that refers to the model and used to see the causal relationships between variables

General model, VAR with lag1;

� =� � +� � �− +� � �− +��

� =� �+� � �− +� � �− +��

The advocates of VAR emphasize these virtues of the method; (1) the method is simple; one does not have to worry about determining which variables are endogenous and which one is exogenous. All variables in VAR are endogenous. (2) Estimation is simple; that is, the usual OLS method can be applied to each equation separately. (3) The forecasts obtained by this method are

in many cases better than those obtained from the more complex simultaneous-equation models. (Gujarati, Damodar N. 2004)

b. Vector Error Correction Model (VECM) is restricted VAR used for nonstationary data series that are known to be cointegrated. The VECM restricting the long-run relationship among endogenous variables and changing them into their cointegration relationship, while allowing their short-run adjustment dynamics. The short-run adjustments correcting the movement of long-run’s deviation equilibrium gradually that is called cointegration term or known as error term. (Basuki and Yuliadi, 2015) The process of VAR/VECM method will be shown below;

Figure 3.1

VAR/VECM analysis process

No Yes

Low High Between Error L-term L-term Yes No L-term S-term Data Transformation

(Natural Log) Data Exploration

Unit Root

Stationary at fisrt difference [I(1)] Stationary at level

[I(0)] Correlation Test Cointegration Test VAR Level S-VAR VECM Optimal Order Cointegration Rank VAR First Different (K-1) Order S-term

3.5.4 Impulse Response Function

Impulse Response Function (IRF) estimation is needed to determine an endogenous variable response to shocks specific variables. IRF also used to see the shockscaused by the other variables and how long these effects occur (Nugroho, 2009). Through IRF, the response of an independent change of one standard deviation can be reviewed. IRF explore the impact of interference by one standard error as an innovation on an endogenous variable against other endogenous variable. An inovation on a variable, will directly impact the variable in question, and then proceed to all other endogenous variables through the dynamic structure of the VAR (Nugroho, 2009).

3.5.5 Variance Decomposition Test

Variance decomposition, the decomposition of the variance of the endogenous variables into the component surprises endogenous variables VAR else in the system. This explains the variance decomposition proportions due to the movement of a series of variables surprise itself compared with other variables surprise. (Nugroho, 2009). The variance decomposition will provide information on the proportion of the movement the shock effect to the shock on other variables in the current period and future periods (Ajija, 2011).

CHAPTER IV RESEARCH FINDINGS

4.1 Researched Variables Overview

This sub-chapter will introduce the variables used in this research. This research has three variables from five countries which are; Export (EXPT), Import (IMPT), and nominal exchange rate of the countries (EXR). Total varibles used in this research are fiveteen variables which taken monthly from year 2005 to 2015. The data of the countries will be processed one by one, and then compared between countries to see how strong the economics of the selected ASEAN-5 countries are.

4.1.1 Country’s Trade Balance Overview

The data shows the movement of exports and imports from ASEAN-5 countries are fluctuated. Trade balance experienced a recession in 2008 caused by the sub-prime mortgages that occurred in the US, resulting the currency shocks that ultimately affect the trade balance. After 2008, the trade balance stably improved. The following table fluctuations in exports and imports of the five Asian countries.

Figure 4.1 Singapore’s trade balance

Singapore has the highest trade value among the sample countries. That is because Singapore does not have natural resources as a commodity which can be traded, resulting Singapore heavily relies on commodities produced by other countries through trade to meet the needs of their country. Can be seen in the chart above that the movement of exports and imports from countries Singapore tend to be stable and increasing. Gap generated by both variables are also not too big. This is because Singapore produce the exported commodities by importing raw materials from abroad

. 0 10000 20000 30000 40000 50000 A p ri l O ct o b e r A p ri l O ct o b e r A p ri l O ct o b e r A p ri l O ct o b e r A p ri l O ct o b e r A p ri l O ct o b e r A p ri l O ct o b e r A p ri l O ct o b e r A p ri l O ct o b e r A p ri l O ct o b e r A p ri l O ct o b e r

Trade Balance Permormance

Figure 4.2 Malaysia’s trade balance

Malaysia is a country blessed with natural resources such as agriculture, forestry, and mining. In the agricultural sector, Malaysia is one of the largest exporter of natural rubber and palm oil, which together with sawn logs and sawn timber, cocoa, pepper, pineapple and tobacco dominate the growth of the sector. Palm oil is also a major generator of Malaysia's international trade. Tin and petroleum are the two main mineral resources are becoming major economic backer Malaysia. Malaysia was once the largest tin producer in the world until the collapse of the tin market in the beginning of the 1980s. In the 19th century and 20th century, tin played a predominant role in the Malaysian economy. In 1972 the petroleum and natural gas took over from tin as the mainstay of the mineral extraction sector. Meanwhile, the contribution by tin has declined. The discovery of petroleum and natural gas in oil fields off Sabah, Sarawak and Terengganu have contributed much to the Malaysian economy. Other minerals of some importance or significance include copper, bauxite, iron, and coal together with industrial minerals such as clay, kaolin, silica, limestone, barite, phosphates and

dimension stones such as granite as well as marble blocks and slabs. (http://www.tradingeconomics.com/malaysia/balance-of-trade)

Figure 4.3 Thailand trade balance

As an export oriented country, Thailand is highly exposed to external economic shocks, which lower demand for Thailand products, thus affecting the trade balance. Thailand major exports are electronics, vehicles, machinery and equipment. The country mainly imports fuel, electronic and machinery appliances. Main trading partner are Japan (10 percent of total exports and 20 percent of total imports) and China (12 percent of total exports and 15 percent of total imports). Others include: the European Union, the United States and Malaysia. (http://www.tradingeconomics.com/thailand/balance-of-trade) 0 5000 10000 15000 20000 25000 30000 A p ri l O ct o b e r A p ri l O ct o b e r A p ri l O ct o b e r A p ri l O ct o b e r A p ri l O ct o b e r A p ri l O ct o b e r A p ri l O ct o b e r A p ri l O ct o b e r A p ri l O ct o b e r A p ri l O ct o b e r A p ri l O ct o b e r

Trade Balance Performance

Figure 4.4 Indonesia’s trade balance

Since the 2000’s Indonesia has been recording consistent trade surpluses due to robust exports growth. However, from due to the shock on 2008, the value of export and import falling as the other countries does, yet the countries sustain the economic turmoil. In 2012 to 2014 the country started recording trade deficits, as exports shrank due to slowdown in the global economy and fall in commodity prices. In 2015, trade balance swing again to surplus due to almost 20 percent fall in imports. In recent years, the biggest trade deficits were recorded with China, Thailand, Japan, Germany and South Korea. Indonesia records trade surpluses mainly with India, United States, and Malaysia.

(http://www.tradingeconomics.com/indonesia/balance-of-trade).

According to (Imamudin Yuliadi, 2008) in his paper, found that Indonesia is still counting on re-export products, in other words importing a middle raw material for exports prudctions. The results also imply about the pattern of trade conducted by the Indonesian entrepreneurs that they conducting a transactions with other states based on job orders by utilizing a cheap labor to seize a share of

international market. This situation illustrates that with the higher import content for export products will reducing a value-added export products nationwide.

Figure 4.5 Philippine trade balance

Philippine has suffer the trade deficits over a years. Philippine has been running annual trade deficits due to high imports of raw materials and intermediate goods. The trade balance should worsen due to the rapid rise in imports stimulated both by household consumption and the input needs for industry. Recent data showed export fluctuated extreamly after the shock held in 2008. The weak level of the currency has done little to boost exports, which should appear more affordable to foreigners, raising concerns about underlying global demand. (https://psa.gov.ph/business/foreign-trade)

From the trade balance overview of ASEAN-5 countries, all of those countries showing the same pattern of exports and imports performance. From 2005 until 2007 the trade balance movements showing an increasing value of exports imports, then fall in 2008 and 2009. This pattern caused by the external shocks came from United State economic caused by sub-prime morgate.

0,00 2.000,00 4.000,00 6.000,00 8.000,00 Jan u ar y Jul y Jan u ar y Jul y Jan u ar y Jul y Jan u ar y Jul y Jan u ar y Jul y Jan u ar y Jul y Jan u ar y Jul y Jan u ar y Jul y Jan u ar y Jul y Jan u ar y Jul y Jan u ar y Jul y

Trade Balance Performance

4.2 Research Findings and Discussion

This research use the econometical approaches to analyze the trade balance performance of ASEAN-5 countries and the interraction towards exchange rate fluctuation. In order to get the best result, we follow the standard procedure of time series analyses by following these procedures:

1. Unit Root Test – Augmented Dickey Fuller and Phillips-Perron Test

2. Correlation Matrix – Johansen-Juselius Cointegration Test 3. Vector Auto Regression-based analysis (VAR/VECM) 4. Impulse Response Function

5. Variance Decomposition Test

4.1.1 Unit Root Test

In the econometric examination model used is VAR/VECM model, the first test performed is stationary test to build the proper econometrics model. The unit root test is conducted by observing the value of Akaikie Information Criterion (AIC) and Schwarz Criterion (SC) through Augmented-Dickey-Fuller Test (ADF test) at level and at first difference level. If the t-statistics is value bigger than the critical value, the data is stationary at level and can be analyzed using VAR methods. But, if the t-statistics value is smaller than the critical value, then the data is not stationary at level. ADF-test is used to examine the stationary data and lag length of all variables in this research in level and first difference. From the

122

21 3.439066 89.87044 6.980152 3.149408 22 3.514030 89.75000 7.075941 3.174054 23 3.587424 89.63928 7.164013 3.196708 24 3.659345 89.53714 7.245253 3.217607 25 3.729879 89.44265 7.320411 3.236937 26 3.799103 89.35499 7.390142 3.254869 27 3.867088 89.27343 7.455012 3.271553 28 3.933898 89.19738 7.515510 3.287111 29 3.999592 89.12628 7.572064 3.301655 30 4.064225 89.05967 7.625048 3.315282 Variance

Decomposition of EXPT:

Period S.E. EXR EXPT IMPT

1 1205.147 2.866969 97.13303 0.000000 2 1336.370 2.775257 97.11909 0.105657 3 1455.536 2.373518 92.40392 5.222559 4 1526.609 3.000847 91.36911 5.630041 5 1604.444 5.762548 87.81312 6.424329 6 1679.044 9.153913 82.83104 8.015049 7 1758.037 13.23066 78.13332 8.636022 8 1839.928 17.44205 73.53607 9.021888 9 1919.561 21.03333 69.44265 9.524012 10 1996.489 24.15474 66.04050 9.804766 11 2071.094 26.85293 63.13180 10.01527 12 2142.498 29.11997 60.63454 10.24549 13 2211.229 31.07344 58.49982 10.42674 14 2277.775 32.78679 56.63112 10.58209 15 2342.209 34.29277 54.97296 10.73427 16 2404.807 35.63667 53.49532 10.86801 17 2465.811 36.84885 52.16376 10.98738 18 2525.316 37.94627 50.95487 11.09887 19 2583.444 38.94629 49.85387 11.19984 20 2640.307 39.86230 48.84606 11.29164 21 2695.975 40.70370 47.91973 11.37657 22 2750.519 41.47934 47.06599 11.45467 23 2804.008 42.19672 46.27663 11.52665 24 2856.497 42.86191 45.54456 11.59353 25 2908.039 43.48039 44.86395 11.65566 26 2958.683 44.05692 44.22955 11.71353 27 3008.476 44.59558 43.63679 11.76763 28 3057.457 45.09998 43.08173 11.81828 29 3105.666 45.57331 42.56089 11.86581 30 3153.137 46.01834 42.07117 11.91050 Variance

Decomposition of IMPT:

Period S.E. EXR EXPT IMPT

1 1429.667 0.816589 27.02147 72.16194 2 1617.460 1.861894 37.22689 60.91122 3 1846.397 2.199561 39.87055 57.92989 4 2057.174 2.004132 36.51915 61.47672 5 2222.290 2.433018 36.80938 60.75761

123

6 2377.845 3.237399 36.08680 60.67580 7 2533.347 3.780386 34.72234 61.49727 8 2672.228 4.405623 34.07436 61.52001 9 2805.978 5.016599 33.47265 61.51075 10 2935.510 5.478060 32.83590 61.68604 11 3058.025 5.882470 32.40752 61.71001 12 3175.959 6.236432 32.04738 61.71619 13 3290.165 6.523213 31.71067 61.76612 14 3400.153 6.771867 31.44070 61.78743 15 3506.692 6.991457 31.20636 61.80218 16 3610.217 7.181787 30.99161 61.82660 17 3710.769 7.351472 30.80411 61.84442 18 3808.659 7.504601 30.63624 61.85916 19 3904.132 7.642269 30.48256 61.87517 20 3997.306 7.767364 30.34371 61.88893 21 4088.354 7.881754 30.21724 61.90101 22 4177.429 7.986410 30.10091 61.91268 23 4264.639 8.082633 29.99414 61.92323 24 4350.100 8.171453 29.89573 61.93282 25 4433.917 8.253598 29.80458 61.94182 26 4516.177 8.329813 29.72005 61.95014 27 4596.966 8.400732 29.64143 61.95784 28 4676.359 8.466868 29.56809 61.96505 29 4754.427 8.528692 29.49952 61.97179 30 4831.233 8.586618 29.43529 61.97809 Cholesky Ordering:

EXR EXPT IMPT

Indonesia

Variance Decomposition of EXR:

Period S.E. EXR EXPT IMPT

1 373.9037 100.0000 0.000000 0.000000 2 586.5315 98.80890 1.021100 0.170003 3 705.7220 97.61279 1.903170 0.484036 4 799.7679 96.00310 2.604032 1.392866 5 889.7447 93.97328 3.247459 2.779262 6 973.7182 91.86660 3.915972 4.217425 7 1052.462 89.56224 4.603056 5.834699 8 1128.062 87.16338 5.251160 7.585458 9 1201.256 84.77404 5.871981 9.353977 10 1272.519 82.40034 6.466072 11.13359 11 1342.152 80.08370 7.023844 12.89246 12 1410.365 77.84961 7.547523 14.60287 13 1477.324 75.70706 8.037208 16.25573 14 1543.110 73.66704 8.493144 17.83981 15 1607.788 71.73325 8.917358 19.34940 16 1671.407 69.90581 9.311398 20.78279 17 1733.997 68.18371 9.677128 22.13916 18 1795.585 66.56366 10.01658 23.41976 19 1856.192 65.04148 10.33164 24.62689 20 1915.836 63.61247 10.62417 25.76336 21 1974.533 62.27149 10.89595 26.83255

124

22 2032.303 61.01333 11.14865 27.83803 23 2089.161 59.83277 11.38381 28.78342 24 2145.125 58.72476 11.60286 29.67238 25 2200.214 57.68441 11.80714 30.50846 26 2254.446 56.70708 11.99783 31.29509 27 2307.840 55.78839 12.17606 32.03555 28 2360.416 54.92423 12.34283 32.73294 29 2412.193 54.11076 12.49906 33.39018 30 2463.192 53.34442 12.64559 34.01000 Variance Decomposition of

EXPT:

Period S.E. EXR EXPT IMPT

1 916.0765 0.921198 99.07880 0.000000 2 1023.901 0.911966 98.62831 0.459725 3 1223.178 4.153972 95.30660 0.539427 4 1395.555 4.787531 94.36317 0.849296 5 1538.041 4.925908 94.33232 0.741776 6 1684.853 4.775939 94.28188 0.942183 7 1821.888 4.649478 93.95440 1.396120 8 1954.022 4.506582 93.74797 1.745450 9 2084.497 4.301052 93.44152 2.257428 10 2210.466 4.107737 93.07733 2.814933 11 2333.765 3.920083 92.71404 3.365873 12 2454.753 3.734785 92.31364 3.951580 13 2572.986 3.561622 91.90515 4.533229 14 2688.973 3.398733 91.49604 5.105222 15 2802.754 3.246174 91.08458 5.669246 16 2914.331 3.104576 90.68004 6.215380 17 3023.855 2.972962 90.28422 6.742822 18 3131.363 2.850858 89.89868 7.250463 19 3236.909 2.737692 89.52593 7.736383 20 3340.564 2.632725 89.16654 8.200736 21 3442.376 2.535347 88.82114 8.643514 22 3542.398 2.444945 88.49012 9.064931 23 3640.685 2.360933 88.17342 9.465647 24 3737.285 2.282782 87.87090 9.846323 25 3832.250 2.209998 87.58226 10.20774 26 3925.629 2.142130 87.30710 10.55077 27 4017.469 2.078766 87.04496 10.87627 28 4107.817 2.019533 86.79534 11.18513 29 4196.721 1.964088 86.55769 11.47822 30 4284.224 1.912124 86.33147 11.75641 Variance Decomposition of

IMPT:

Period S.E. EXR EXPT IMPT

1 1004.527 0.751836 42.72032 56.52785 2 1138.359 1.116941 49.86614 49.01692 3 1302.878 6.003049 52.14275 41.85420 4 1468.147 6.934190 56.66091 36.40490 5 1596.539 6.819668 61.41428 31.76605 6 1717.237 6.814826 65.25118 27.93399 7 1837.092 6.661001 68.76472 24.57428 8 1952.645 6.396551 71.83489 21.76856

125

9 2066.033 6.101191 74.45157 19.44724 10 2178.608 5.785114 76.67953 17.53536 11 2290.121 5.467162 78.54360 15.98923 12 2400.897 5.156700 80.09541 14.74789 13 2511.052 4.858277 81.37494 13.76678 14 2620.460 4.576355 82.42121 13.00243 15 2729.114 4.312206 83.27155 12.41624 16 2836.938 4.066189 83.95635 11.97746 17 2943.831 3.838219 84.50328 11.65850 18 3049.730 3.627518 84.93577 11.43671 19 3154.558 3.433122 85.27340 11.29348 20 3258.252 3.253954 85.53294 11.21310 21 3360.761 3.088856 85.72829 11.18285 22 3462.043 2.936697 85.87102 11.19228 23 3562.064 2.796384 85.97080 11.23282 24 3660.804 2.666885 86.03561 11.29751 25 3758.246 2.547241 86.07205 11.38071 26 3854.384 2.436568 86.08559 11.47784 27 3949.216 2.334058 86.08074 11.58520 28 4042.747 2.238975 86.06121 11.69982 29 4134.987 2.150654 86.03005 11.81929 30 4225.949 2.068492 85.98979 11.94172 Cholesky Ordering: EXR

EXPT IMPT

Philippine

Variance Decomposition of EXR:

Period S.E. EXR EXPT IMPT

1 0.629901 100.0000 0.000000 0.000000 2 1.110795 99.63604 0.025867 0.338091 3 1.466008 98.98990 0.023550 0.986549 4 1.724265 98.99327 0.023073 0.983661 5 1.938620 99.15404 0.045223 0.800741 6 2.127635 99.24708 0.088074 0.664841 7 2.297788 99.29502 0.131960 0.573018 8 2.453432 99.32338 0.169342 0.507282 9 2.598390 99.34202 0.200367 0.457609 10 2.735282 99.35620 0.225672 0.418128 11 2.865599 99.36829 0.246233 0.385478 12 2.990267 99.37905 0.263071 0.357877 13 3.109981 99.38864 0.277100 0.334262 14 3.225295 99.39711 0.289016 0.313872 15 3.336656 99.40459 0.299300 0.296113 16 3.444436 99.41119 0.308288 0.280523 17 3.548952 99.41704 0.316225 0.266735 18 3.650479 99.42225 0.323290 0.254460 19 3.749258 99.42691 0.329623 0.243463 20 3.845501 99.43111 0.335333 0.233554 21 3.939393 99.43491 0.340506 0.224580

126

22 4.031098 99.43837 0.345215 0.216414 23 4.120762 99.44153 0.349518 0.208952 24 4.208516 99.44443 0.353467 0.202105 25 4.294478 99.44710 0.357103 0.195801 26 4.378752 99.44956 0.360462 0.189978 27 4.461434 99.45184 0.363573 0.184582 28 4.542612 99.45397 0.366465 0.179569 29 4.622365 99.45594 0.369158 0.174898 30 4.700764 99.45779 0.371674 0.170537 Variance Decomposition of

EXPT:

Period S.E. EXR EXPT IMPT

1 389.4277 1.648282 98.35172 0.000000 2 447.8711 1.311530 98.29738 0.391094 3 516.6948 2.643613 94.74922 2.607165 4 576.4504 3.620376 93.13692 3.242702 5 626.9701 3.927003 92.33207 3.740923 6 674.4086 4.040367 91.66209 4.297539 7 718.2008 4.102128 91.07209 4.825781 8 759.3929 4.147698 90.58423 5.268069 9 798.4245 4.177170 90.20253 5.620298 10 835.6069 4.196171 89.89486 5.908973 11 871.2142 4.211254 89.63765 6.151097 12 905.4282 4.224792 89.41904 6.356171 13 938.4001 4.237053 89.23135 6.531593 14 970.2551 4.247997 89.06847 6.683530 15 1001.099 4.257749 88.92553 6.816725 16 1031.021 4.266476 88.79892 6.934603 17 1060.099 4.274307 88.68598 7.039709 18 1088.401 4.281348 88.58463 7.134027 19 1115.985 4.287701 88.49315 7.219147 20 1142.903 4.293459 88.41019 7.296355 21 1169.202 4.298702 88.33459 7.366704 22 1194.922 4.303497 88.26544 7.431065 23 1220.100 4.307898 88.20193 7.490169 24 1244.769 4.311954 88.14341 7.544636 25 1268.959 4.315703 88.08931 7.594989 26 1292.696 4.319179 88.03914 7.641678 27 1316.004 4.322411 87.99250 7.685088 28 1338.907 4.325424 87.94902 7.725553 29 1361.425 4.328239 87.90840 7.763363 30 1383.577 4.330876 87.87035 7.798771 Variance Decomposition of

IMPT:

Period S.E. EXR EXPT IMPT

1 398.0049 0.155794 13.20556 86.63864 2 483.6942 0.689938 24.11007 75.19999 3 529.6230 0.941685 29.29132 69.76699 4 583.4832 1.797174 37.76274 60.44009 5 629.9525 2.666882 43.86197 53.47115 6 675.9607 3.712383 48.60888 47.67874 7 719.8859 4.705377 52.29302 43.00160 8 761.3846 5.542486 55.18357 39.27394

127

9 800.8379 6.230212 57.50683 36.26295 10 838.3853 6.795850 59.40382 33.80033 11 874.2787 7.266786 60.98425 31.74897 12 908.7197 7.663545 62.32522 30.01124 13 941.8773 8.002249 63.47924 28.51852 14 973.8946 8.295395 64.48363 27.22097 15 1004.887 8.552173 65.36604 26.08179 16 1034.950 8.779282 66.14755 25.07317 17 1064.164 8.981731 66.84458 24.17369 18 1092.598 9.163391 67.47010 23.36651 19 1120.310 9.327333 68.03454 22.63813 20 1147.354 9.476029 68.54641 21.97756 21 1173.775 9.611508 69.01273 21.37576 22 1199.614 9.735450 69.43930 20.82525 23 1224.908 9.849265 69.83100 20.31974 24 1249.691 9.954142 70.19193 19.85393 25 1273.991 10.05109 70.52559 19.42332 26 1297.837 10.14099 70.83495 19.02406 27 1321.252 10.22456 71.12257 18.65286 28 1344.260 10.30247 71.39067 18.30686 29 1366.880 10.37526 71.64118 17.98357 30 1389.132 10.44342 71.87575 17.68083 Cholesky Ordering: EXR