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Equilibrium exchange rates in oil-exporting countries

Journal of Economics and Finance volume 33, pages 71–79 (2009)Cite this article

Abstract

We assess the determinants of equilibrium real exchange rates in a sample of oil-dependent countries. Our data cover OPEC countries from 1975 to 2005. Utilising pooled mean group and mean group estimators, we find that the price of oil has a clear, statistically significant effect on real exchange rates in our group of oil-producing countries. Higher oil price lead to appreciation of the real exchange rate. Elasticity of the real exchange rate with respect to the oil price is typically between 0.4 and 0.5, but may be even larger depending on the specification. Real per capita GDP, on the other hand, does not appear to have a clear effect on real exchange rate. This latter result contrasts starkly with many earlier papers on real exchange rate determination, emphasising the unique position of oil-dependent countries.

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Notes

  1. After the experience of the Netherlands in the 1970s after natural gas was discovered off its coast.

  2. Naturally, economic policy can be used to counteract the effects of higher export prices. Central banks can accumulate foreign currency reserves and at least try to sterilize the resulting increase in domestic liquidity. In addition, many oil-producing countries have in recent years introduced sovereign wealth funds, which are usually designed to keep a large portion of the oil and gas revenues out of the country, so that they do not add to domestic demand. Instead the funds are invested in high-grade securities for longer term, and usually the proceeds are supposed to benefit the future generations. While this kind of arrangement may hamper the link between positive terms of trade shocks and the real exchange rate, in our sample of countries this mechanism was probably not very effective during the sample period. Kuwait may be a partial exception to this, as its fund has been operating since 1953, and its size is currently approximately US$210 billion (Beck and Fidora 2008). To further check for the short-run effect of oil price on GDP growth, we regressed real GDP growth on the change of real oil price in the nine OPEC countries between 1975 and 2005 with country-specific fixed terms included. Coefficient on real oil price change is positive (0.05) and statistically significant (p-value 0.008). The results are available from the authors upon request.

  3. We initially included net foreign asset position as a control variable in this study. It was, however, statistically insignificant in practically all specifications and/or had a sign not predicted by theory. Therefore, we have omitted net foreign asset position in these estimations.

  4. Algeria (AL), Ecuador (EC), Gabon (GA), Indonesia (IND), Iran (IR), Kuwait (KUW), Nigeria (NIG), Saudi Arabia (SA) and Venezuela (VE).

  5. In fact, one can also choose to restrict only some long-run coefficients to be the same, and allow others to differ across cross-sections.

  6. For ease of exposition, the error correction equation is written for the case when only one lag of the right-hand side variables is included.

  7. The exception is the specification where the reer equation is estimated without a trend. In this case, the Hausmann test rejects pooling anyway.

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Acknowledgements

We wish to thank Aaron Mehrotra, Jarko Fidrmuc and an anonymous referee for excellent comments on previous drafts of this paper. The remaining errors and omissions are naturally ours.

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Authors and Affiliations

  1. Bank of Finland, P.O. Box, 160, 00101, Helsinki, Finland

    Iikka Korhonen

  2. MS MC13-1314, World Bank, 1818 H Street, NW Washington, DC, 20433, USA

    Tuuli Juurikkala

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  1. Iikka Korhonen
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  2. Tuuli Juurikkala
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Correspondence to Iikka Korhonen.

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Korhonen, I., Juurikkala, T. Equilibrium exchange rates in oil-exporting countries. J Econ Finance 33, 71–79 (2009). https://doi.org/10.1007/s12197-008-9067-x

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  • DOI: https://doi.org/10.1007/s12197-008-9067-x

Keywords

  • Equilibrium exchange rate
  • Pooled mean group estimator
  • Resource dependency

JEL codes

  • F31
  • F41
  • P24
  • Q43