On the other hand, this study adopts the Granger Causality test in order to investigate causality relationships between variables with no cointegration
associations Giles 2011; Gogoi 2014. Moreover, the lag lengths generated by the Schwarz Information Criterion SIC are employed in this study because it suggests
the most parsimonious model compared to Akaike Information Criterion AIC.
5.3 VECM Analysis
A VECM model can be used to identify long-run and short-run relationships between the prices of oil and food commodities. This method defines a framework
where the dynamics of the short-run relations of each price series are bound to the long-run equilibrium relations.
As shown in Table 5.3 below, the VECM results confirm a bidirectional long term association between domestic price of maize and crude oil prices, implying
that the price of maize in Indonesia is being caused by crude oil prices and vice versa. Similarly, results show that there is a bidirectional long term relationship
between domestic petroleum prices and crude oil prices. Therefore, these results indicate that in the long run crude oil prices can directly affect the domestic price
of maize through changes in the cost of production due to the intensive use of fossil fuel, whereas the reverse relationships suggest that the domestic price of maize and
petroleum seem to be the leading indicator of crude oil price fluctuations.
Table 5.3 Results of VECM
Relationships Direction of Causality
Domestic Food Commodity – Crude Oil:
Domestic Maize – Crude Oil
LMZ ⇔ CO
Domestic Petroleum – Crude Oil:
Domestic Petroleum – Crude Oil
PO ⇔ CO
World Food Commodity – Crude Oil:
World Rice – Crude Oil
WRC ⇔ CO
World Wheat – Crude Oil
WWHT ⇔ CO
World Soybean – Crude Oil
WSOY ⟹ CO
World Palm Oil – Crude Oil
WPLM ⟹ CO
Domestic Food Commodity – World Food Commodity:
Domestic Maize – World Maize
WMZ ⟹ LMZ
Domestic Wheat – World Wheat
LWHT ⇔ WWHT
Domestic Soybean – World Soybean
WSOY ⟹ LSOY
In the context of world food commodity prices and crude oil prices, results reveal unidirectional long-run causalities from world soybean prices to crude oil
prices and from world palm oil prices to crude oil prices. The existence of these relationships may be caused by massive use of soybeans and palm oil as feedstocks
in the production of biofuel during the past decade. Furthermore, results show bidirectional causalities between rice prices in the world market and crude oil prices,
and world wheat prices and crude oil prices. This means that volatilities in crude oil prices can be directly transmitted onto rice and wheat prices in the world market in
the long run and inversely, changes in the world prices of rice and wheat can affect crude oil prices. The volatilities spillover from the world price of wheat onto the
price of crude oil may occur as wheat is used for producing biofuels. Thus, rising
demand for biofuel can affect the price of crude oil. Moreover, the development of biofuel also affects non-feedstock crops, such as rice, because farmers prefer to
grow feedstock crops instead of food crops, indicating that the price of rice may become a leading indicator of changes in crude oil prices Tenenbaum 2008.
Therefore, the world prices of both wheat and rice can indirectly affect the price of crude oil.
In terms of the relationships between domestic food commodity prices and their corresponding food commodity prices in the world market, the results confirm
unidirectional long-run associations running from world soybean prices to domestic soybean prices and from world maize prices to domestic maize prices. These
indicate that the changes in world soybean prices can affect the domestic soybean prices, but prices of domestic soybeans cannot influence soybean prices in the
global market. Likewise, the domestic maize prices can be affected by fluctuations in the world prices of maize.
Bidirectional long-run relationships can be found in the linkages between the world price of wheat and the domestic price of wheat in Indonesia. These
associations suggest that the world price of wheat can influence the domestic price of wheat, and in reverse, domestic wheat prices can affect world wheat prices. The
existence of bidirectional relationships between these variables may be caused by substantially high domestic demand for wheat in Indonesia, making it the third
largest wheat importing country in the world.
Overall, the VECM results reveal that in the long run crude oil prices can directly affect the domestic price of maize and the world prices of rice and wheat.
Crude oil prices may also indirectly affect domestic prices of wheat through the world price of wheat since Indonesia heavily imports this commodity. Similarly,
there is a possibility that domestic prices of maize and soybeans may be affected by the prices of their corresponding food commodities in the global market as these
commodities are imported in large quantities to fulfill the national demand.
5.4 Granger Causality Test
The aim of the Granger Causality test is to investigate the existence of causation relationships between two economic variables in the short run. This study
adopts the VAR Pairwise Granger Causality test at the 5 level of significance and uses SIC to choose the optimal length of lag for the test. The test is conducted for
all bivariate analyses having no cointegration relationships.
As shown in Table 5.4, there is a two-way causal relationship between the domestic price of rice and crude oil prices, implying that in the short term the price
of crude oil Granger causes the domestic price of rice, and inversely, the domestic rice price Granger causes crude oil price. The former relationship is as expected as
it shows the direct effect of crude oil prices on food prices, whereas the latter relationship does not fit this pattern. The one-way causation between the domestic
price of wheat and crude oil price also shows similar direction with the latter relationship. These suggest that both domestic prices of rice and wheat may become
leading indicators for crude oil prices, signaling future changes in oil prices. In addition, the results also reveal that the price of domestic cooking oil may Granger
cause crude oil prices. A possible explanation for this result is due to Indonesia
being the largest crude palm oil exporter in the world. Rising cooking oil prices encourages farmers to produce crude palm oil intended for producing cooking oil
instead of biofuel. The reduction in the supply of feedstock could trigger an increase in biofuel prices and hence affect the demand for biofuel as consumers may
substitute biofuel for fossil fuel. This substitution then could affect crude oil prices.
Table 5.4 Results of Granger Causality test
Relationships Direction of Causality
Domestic Food Commodity – Crude Oil:
Domestic Rice – Crude Oil
LRC ⇔ CO
Domestic Wheat – Crude Oil
LWHT ⟹ CO
Domestic Soybean – Crude Oil
- Domestic Sugar
– Crude Oil -
Domestic Cooking Oil – Crude Oil
LCOOK ⟹ CO
Domestic Food Commodity – Domestic Petroleum:
Domestic Rice – Domestic Petroleum
- Domestic Maize
– Domestic Petroleum -
Domestic Wheat – Domestic Petroleum
- Domestic Soybean
– Domestic Petroleum -
Domestic Sugar – Domestic Petroleum
- Domestic Cooking Oil
– Domestic Petroleum
- World Food Commodity
– Crude Oil: World Maize
– Crude Oil WMZ
⟹ CO World Sugar
– Crude Oil -
Domestic Food Commodity – World Food Commodity:
Domestic Rice – World Rice
- Domestic Sugar
– World Sugar -
Domestic Cooking Oil – World Palm Oil
WPLM ⟹ LCOOK
In contrast, the Granger causality test does not identify any short-run causalities in the linkages between domestic soybean prices and crude oil prices,
and between the domestic price of sugar and the price of crude oil. Similarly, this test reveals that there are no causality relationships between domestic prices of food
commodities and domestic price of petroleum. A plausible reason for this finding is because of massive fuel subsidies provided by the government of Indonesia,
allowing more stable fuel prices. Hence, this could break the relationships between the prices of domestic food commodities and the domestic price of petroleum and
explain the absence of cointegration associations between them.
In terms of short-run causalities between world prices of food commodities and crude oil prices, the Granger Causality test shows unidirectional causation
running from the world price of maize to the price of crude oil. This result is similar to findings in a previous study by Zhang et al. 2009, which confirms that corn
prices granger cause prices of oil. World prices of maize can affect crude oil prices because maize is used for producing biofuel. An increase in the world price of maize
may be caused by the rising use of maize as feedstocks instead of food sources. This indicates that there may be an increase in the demand for biofuel as a response to
high fossil fuel prices. However, this study does not find evidence for existence of either short-run or long-run causalities between the world price of sugar and the
price of crude oil. This result is consistent with the findings of Obadi and Korček 2014, confirming the absence of such associations in the linkage between the
prices of sugar and oil.
