Could drop in oil price augur good for economy?
Searched the answer spending hours many,
Data on current account and crude oil price
Revealed an unpleasant surprise.
Contrary to belief, current account sustained deficit
Slide from $70 may also hurt forex receipt.
IRF says oil price shock has lasting effect,
This time, positive outcome is what I expect.
In international market, crude oil price hit a nadir after two leading producers had failed to reach agreement on production level.
A local news report says it augurs good for Bangladesh Petroleum Corporation, Bangladesh’s biggest corporation with annual turnover of Tk 250 billion, since government will no longer have to subsidize its operations and it will again walk along the profit-making path.
Lower oil price also means cost of import and cost of production will be much lower. This is happening when aggregate demand in the world market is falling. Investment and infrastructure projects are being postponed. However, export orders are also being called off.
I was keen to look at what it means for current account balance (CAB), which registered negative for the last couple of years. I gathered the old crude oil price data from my earlier analysis on BPC profit/loss, delving macrotrend and updated it for $33 / barrel in 2020. I gleaned the data on CAB from Bangladesh Bank website. Data for 2020 were only available for July-December period.
Since crude oil price influences import and export item prices, it is assumed that current account balance depends on crude oil price.
A quick look at the data revealed that between 2010 and 2020, economy witnessed current account deficit when the crude oil price was well below the $70/barrel, a much talked about price to sustain the economies of Middle East. It is contrary to the belief that a fall in crude oil price improves current account balance. I am still in that group of believers. It is also important to note that Bangladesh embarked upon big infrastructure and investment projects in the given period. Maybe that is the reason for big current account deficit. As I was interested to see the impact of crude oil price on CAB, I needed to fit a model.
First, I carried out some diagnostic Check. Time series data called for autocorrelation check. Durbin-Watson statistic (d=1.22 for 11 observations and 1 explanatory variable) fell into indecisive zone. So I went for modified Durbin-Watson check. It reported positive autocorrelation( d=1.22 < d
u = 1.324).
However, I did not transform the regression to make it generalized difference equation. I worked on the serially correlated data and checked for stationarity. To check for stationarity, following regressions were constructed:
🔺 CAB
t = a + b CAB
t-1 + ct + d 🔺 CAB
t-1
🔺 Crude
t = a + b Crude
t-1 + ct + d 🔺 Crude
t-1
Where 🔺 CAB
t= Differences at current account balances at t,
CAB
t-1 = current account balances at t-1,
🔺 Crude
t= Differences at crude oil prices at t,
Crude
t-1= crude oil price at t-1,
🔺 Crude
t-1= Differences at crude oil prices at t-1,
t = a time trend variable, here year.
Tau statistics of slope coefficients of lagged CAB and Crude, -2.33 & -2.3 , in absolute terms were smaller than ADF critical tau statistics at 5% level, -3.4620, and at 1% level , -4.067. So I did not reject the null hypothesis that b=0 or CAB and Crude show an unit root or they are nonstationary.
Please note that first differences of CAB and Crude did not turn out to be stationary. I did not have patience to difference further and to see at what level they became stationary. So both CAB and Crude, for the sake of simplicity, were integrated of order d, I(d).
To check for cointegration, I first regressed CAB on Crude and got the residuals. Then I ran the following regression:
🔺 resid
t = b resid
t-1 + c 🔺 resid
t-1
At 5% level, critical value , reported in J Hamilton’s Time Series Analysis was -3.37. Since computed -2.79 was greater than -3.37, I did not reject the null hypothesis of no cointegration or residuals are nonstationary.
In this case, CAB and Crude were I(d) series and were not cointegrated. So, I went for a VAR model :
🔺 CAB
t = b
1 🔺 CAB
t-1 + b
2 🔺 CAB
t-2+ b
3 🔺 Crude
t-1 + b
4 🔺 Crude
t-2+ v
t🔺CAB
🔺 Crude
t = c
1 🔺CAB
t-1 + c
2 🔺 CAB
t-2+ c
3 🔺 Crude
t-1 + c
4 🔺 Crude
t-2+ v
t🔺 Crude
VAR model did not fit well as reported by F( for 🔺CAB F= 0.8960, p= 0.54 and for 🔺Crude F= 0.048 , p= 0.99). However I was keen to see the Impulse Response Function(IRF), which shows the effect of a shock to an endogenous variable on itself and on other endogenous variables.
An orthogonalized shock to Crude was reciprocated once or twice by CAB and it died out seven or eight periods later, as shown in the graph. The effect of Crude oil price shock on CAB did not wither away instantly and lasted for quite some time.
Analyzing the data for the last 10 years, it was noticed that Bangladesh sustained current account deficit for the last couple of years when the oil price was well below $70/barrel. However, current account deficit deteriorated when the crude oil price increased. Check the price rise when $86/barrel became $107/barrel in 2011, $53.72/barrel rose to $55.71/barrel in 2017 and $55.71/barrel increased to $66.87/ barrel in 2018. Two things became clear: first, increase in crude oil price evidently hurt current account balance; second, price below $70/barrel did not always generate a current account surplus.
My understanding of the situation is that prices lower than $70/barrel stall many investment and construction projects in the Middle Eastern countries where many Bangladeshis work. As construction work halts , they may be laid off. Remittances, rescuer of current account balance , may also get affected. In addition, higher oil prices generate revenue for investment in many of the occidental countries, contributing to increase in household income. That means more spending on apparel items , leading more orders for Bangladeshi garment factories. This may not last as that high oil price driven revenue may dry up , hurting investment and household income in those countries. So our apparel export may also take a hit because of this. By the way, this is considered without taking into account the Corona effect.
And from the graph it was seen that any rise or fall in Crude oil price had a lasting effect on the current account balance. Could it be different for this time?
