OIL PRICE FLUCTUATION AND ITS IMPACT ON FOREX

MARKET

Dr.J.Gayathri, Assistant

Professor, Department of Commerce and Financial Studies, Bharathidasan

University, S.Felix Sophia, Ph.D. Research Scholar, Department of Commerce and

Financial Studies, Bharathidasan University

and K. Maheswari, Ph.D. Research Scholar, Department of Commerce and

Financial Studies, Bharathidasan University.

Abstract

The

foreign exchange market is the market in which currencies are bought and sold

against each other. It is the largest market in the world. This

paper investigated the long-term relationship

between crude oil prices and exchange rate, the

sample consists of crude oil prices in India and US Dollar Exchange rate in

terms of Indian Rupee, especially real exchange rate. The

study used annual data from 2011 to 2016. Descriptive statistics,

Unit Root Test, Co- integration Test, Granger Causality Test, GARCH Model used

for the study . The study analyses the role of crude oil prices in the price

discovery of US Dollar in the Foreign Exchange Market.

Keywords: Crude

Oil Price, Oil Price Fluctuation, Foreign exchange Market.

INTRODUCTION

The

foreign exchange market is the market in which currencies are bought and sold

against each other. It is the largest market in the world. The daily turnover in the market was

estimated to be over US$ 1 trillion. Bulk

of turnover in foreign exchange market is accounted for by a small number of

currencies – the US dollar, Deutschemark (DM), Yen, Pound sterling, Swiss franc,

Canadian dollar, Dutch guilder, Italian lira and the Belgian franc. The foreign

exchange market is an over -the – counter market. A few giant multinational

banks deal in the large number of currencies, in large amounts and often deal

directly with each other without using brokers. Their transaction can have

significant influence on the market. In the second tier are large banks that

deal in a smaller number of currencies and use the services of brokers more

often. Lastly there are small local institutions which make market in a very

small number of major currencies against their home currencies.

Central banks intervene

in the market from time to time; attempt to move exchange rates in a particular

direction. In case of limited flexibility systems like the EMS, these

interventions are obligatory and, when intervention limits are reached,

potentially unlimited. In other cases, though there is no commitment to defend

any particular rate, a central bank may still intervene to influence market

sentiment.

Globally, the price of

oil has been a significant determinant of the level of economic performance.

The real exchange rate is a significant factor in the development process of an

economy as both its level and stability are important in increasing exports and

private investment. The transmission mechanisms through which oil prices

influence the Real Exchange Rate (RER) include both supply and demand channels.

The supply side effects are related to the fact that crude oil is a basic input

in production and consequently, an increase in oil price leads to a rise in the

cost of production of non-tradable goods will thus increase leading to an

appreciation of the RER. The RER is also indirectly affected through its

relation with disposable income. A rise in oil price reduces the consumers

spending power. This will reduce the demand for non-tradable and therefore to a

fall in their prices. This will depreciate the RER. The presents study focus on

the relationship between stock index return and crude oil price.

REVIEW

OF LITERATURE

The study on “Exchange Rate and Oil Prices” by Robert A. Amano and Simon

Van Norden (1998) explain that the real oil price captures exogenous

terms-of-trade shocks and why such shocks could be the most important factor

determining real exchange rates in the long run

This paper entitled “China and

The Relationship Between The Oil Price and The Dollar” by Agnes Benassy- Quere, Velarie Mignon And

Alexis Penot (2005-16) concluded that Oil price fluctuation in domestic

currency may be quite different depending on the exchange rate regime. For

instance during 2002-2004, rises in oil price was partly cushioned in the Euro

Zone.

The study entitled “Dynamic Relationship Of Exchange Rates And

Crude Oil Prices In South Africa” by

Hamisa Sadi Ali (2015) emphasized the

relevance of crude oil in the global economy can never be ignored

considering its significance as a source of earnings to some countries and as a

source of energy that roll various economic activities in the world.

This study on “The Impact of Oil Prices Volatility on the

Real Exchange Rate in Nigeria” by Onoja,

Joan Egbe (2015) examines the relationship

between oil prices fluctuations and economic activity since the early 1970s.

Empirical studies show that these oil price shocks were immediately followed by

worldwide recession and periods of inflation spurred considerable research.

This paper entitled “The Black Market Exchange Rate and Oil

Prices In Algeria ‘by Yasmina Safaa

Salah (2015) investigate the relationship between oil price

and the black market exchange rate US Dollar/Algerian Dinar through an

empirical analysis using an ECM Model. Results show that a co-integration

relationship is detected between oil and black market exchange rate in Algeria,

with unilateral trend causality in short and long run time horizon from oil

prices to black market exchange rate.

The above studies on

examining the relationship between crude oil price and exchange rate were

mostly made on developed countries and hence the present study was made to

examine the relationship in India.

STATEMENT

OF THE PROBLEM

Oil imports represent a

significant fraction of the trade balance for energy-dependent economies. In

the case of small open economies with floating exchange rate, the variability

in oil prices is expected to have a large impact on the relative value of the

currency. This relationship between the price of oil and the exchange rate has

been established by the literature for oil- producing countries but not for

oil-importing countries.

NEED OF THE STUDY

The determination of causation linkage between crude oil and exchange

rate has important policy implications. The fluctuations in exchange rate

impair the economic growth (rickne, 2009). In these analyses, reducing price

volatility of oil also proves exchange rate stability and hence economic

growth. On the other hand, the information about possible relationship between

oil prices and exchange rate plays crucial role in making long term energy

policies. The determining of causation linkage, policy makers might tend to

alternative energy sources in order to reduce oil dependency and oil demand. In

the light of results, the study also provides information for global investors

in investment decision. By monitoring oil prices, investors may forecast US

dollar movements. Besides, financial market actors and speculators could be

able to identify portfolio diversification options in exchange rate markets.

Secondly, this study also attempts to compare time domain and causality

which generates test statistics at different frequencies across spectra. The

link between the oil price and US dollar exchange rate, which can be observed

since the 1990s, is attracting the interest of many economists. The fact that

commodity prices are mostly denominated in US dollar naturally leads to a

question regarding the relationship between commodity prices and the dollar

exchange rate.

OBJECTIVES OF THE STUDY

Ø To

analyze the normality and stationarity of crude oil prices and exchange rate.

Ø To

investigate the causality between crude oil prices and exchange rate data.

Ø To

investigate the long-term relationship between crude oil prices and exchange

rate.

Ø To

analyses the volatility of crude oil price and exchange rate.

HYPOTHESIS

OF THE STUDY

Ø Ho1 There

is normality and stationarity in the crude oil prices and exchange rate.

Ø Ho2 There

is no causal relationship between crude oil prices and exchange rates.

Ø Ho3 There

is no long-term relationship between crude oil prices and exchange rate.

Ø Ho4 There

is no volatility in the crude oil prices and exchange rate.

METHODOLOGY OF THE STUDY

PERIOD OF THE STUDY:

The present study

covered the time period of the five years from 2011 to 2015.

SAMPLE SELECTION

The sample of consists

of crude oil prices in India and US Dollar Exchange rate in terms of Indian

Rupee, especially real exchange rate. The real exchange rate is calculated

using Nominal Exchange Rate data and inflation rates in India and USA.

SOURCES OF DATA

The study mainly

depends on secondary data. The required secondary data for this study were

collected from the websites namely www.rbi and www.investing .com. Further

the other related information was collected the various website, journals and

Books.

TOOLS

USED FOR THE STUDY

The tools to be used for the study is

1. Descriptive

statistics

2. Unit

Root Test

3. Co

integration Test

4. Granger

causality test

5. GARCH

model.

ANALYSIS AND INTERPRETATION

Table

3.1 Descriptive Statistics Result for the Crude Oil Prices and USD/INR Real

Exchange Rate

Particular

EXCHANGE RETURN

OILRETURN

Mean

0.00674

-0.01002

Median

0.00492

-0.01181

Maximum

0.06272

0.25273

Minimum

-0.04251

-0.20767

Std. Dev.

0.02182

0.08475

Skewness

0.40741

0.09520

Kurtosis

3.22392

3.95423

Jarque-Bera

1.72565

2.28811

Probability

0.42197

0.31853

Sources: Data has been collected from www.rbi.in and computed through E-views

Table 3.1 shows the

results of descriptive statistics for crude oil prices and USD/INR exchange

rate return during the study period from January 2011 to December 2015. It is

to be noted that the summary statistics about sample return, namely mean,

median, maximum, minimum, standard deviations (SD), skewness, and kurtosis were

used to analyse the data. The mean and median value of exchange rate returns

were positive whereas and crude oil prices recorded negative values. The

maximum value of crude oil return is higher than the exchange rate revealing

more changes in the crude oil price. The standard deviation of crude oil price

is highest thus conforming wider fluctuations in crude oil prices. Jarque- Bera

test supports the assumption of Normality.

Table

3.2 Unit Root Test result for the Exchange Rate and Crude Oil Price for five

years from 2011 to 2015

Null Hypothesis

t-Statistic

Prob.*

Augmented

Dickey-Fuller test statistic

-5.61888

0.00

Test critical values:

1% level

-3.5504

5% level

-2.91355

10% level

-2.59452

MacKinnon (1996) one-sided p-values.

Source: Data Collected from www.

Investing.com and computed by using E-views.

Table –3.2 shows the stationary test

for crude oil price and exchange price returns during the study period. It can

be observed from the table that the probability value of ADF-T statistics was

found to be statistically significant. Further ignoring the sign the ADF-T

statistic value for exchange rate price (2.914), crude oil price (2.594) was

greater than the test critical value at 1%, 5%, and 10% level. Hence we reject

the null hypothesis Ho1: “There is

no stationarity in the crude oil prices and exchange rate”. Therefore the time

series data of exchange rate and crude oil has obtained stationarity at level

and it would be helpful for further analysis.

Table

3.3 Result of Co integration between Crude Oil Prices and Real Exchange Rate

Hypothesized

Trace

0.05

Max-Eigen

0.05 critical

No. of CE(s)

Eigen value

Statistic

Critical Value

Prob.**

Statistic

Critical Value

Prob.**

None *

0.321377

40.58226

15.49471

0

21.7106

14.2646

0.0028

At most 1 *

0.286087

18.87166

3.841466

0

18.87166

3.841466

0

Source: Data collected from www. Investing.com and

computed by using E-Views.

Table 3.3 summaries the

result of long run relationship between the exchange rate and crude oil price

for the period of five years from 2011 to 2015. Both the methods like trace

statistics and max-Eigen are considered to find the existence of long run

relationship among the sample indices during the study period. The first column

of table represents the number of co integration vectors exists in the sample

prices. The second column presents the statistical value and critical value by

Max – Eigen method. The statistical value and critical value calculated by the

trace statistics method are provided in the second column of the table and the

final column denotes the probability value. In the above table, the statistical

value is greater than the critical value; also the value of probability is less

than 0.05 (at 95% confidence level). The first row after the header explains

that the statistical value 40.58226 (Max Eigen) and 21.7106 (Trace statistics)

exceeds the critical value 15.49471 and 14.2646 in both (Max Eigen and Trace

Statistic)

the methods. If one moves to the next row, the test statistic of Max Eigen

(3.841466) and

Trace statistic (18.87166) against exceeds the critical value.

Table

3.4 Granger Causality Test Result for the monthly Oil Price and Exchange Rate

Returns

Null Hypothesis:

Obs

F-Statistic

Prob.

Oil Return does not

Granger Cause Exchange Rate Return

56

0.25726

0.7742

Exchange Rate Return

does not Granger Cause Oil Return

0.31326

0.7325

Source: Data Collected from www.investing.com

and www.rbi.in and

computed by using E- views.

Table 3.4 presents the

results of uni- directional Causality for sample. From the table, it is clear

that unit-direction causation was noticed between crude oil prices and exchange

rate prices for monthly price. The test has returned an F-statistic of 0.25726

with a probability of 0.7742, indicating the acceptance of the null hypothesis.

Table 3.5 Showing the

GARCH (1, 1) model Result for the Crude Oil Prices and Real Exchange Rate

Return Price

Mean

Equation

Variable

Coefficient

Std. Error

z-Statistic

Prob.

C

0.00672

0.003039

2.211416

0.027

Oil Return

0.005041

0.041678

0.12096

0.9037

Variance Equation

C

0.000158

0.001386

0.113952

0.9093

GARCH

0.672492

2.900755

0.231834

0.8167

Source: Data Collected from www.rbi.in and computed by using E-Views

Table 3.5 explains the

result of mean equation returns and variance equation of GARCH (1, 1) Model for

crude oil during the study period. It indicates that the probability value was

found to be insignificant. Further, the variance equation has the co-efficient

of GARCH (1, 1) (0.672). It is to be noted that the co-efficient of GARCH (1, 1)

Parameters was less than one (0.672). It is found from the analysis that the

volatility has higher persistent. Hence, the null hypothesis NH04 “There is no

significant volatility crude oil prices and exchange rate” is rejected.

FINDINGS

·

The descriptive

statistics of this study shows that the most of the price index shows a

distribution. The result using the rupee-dollar parallel exchange rates and the

effective exchange Rate evidenced the effect of anticipated and unanticipated

exchange rate movement.

·

The result of standard

deviation explains the level of risk about crude oil price and real exchange

price. The result of causal relationship explains that both the oil price and

real price are affected by other factors, not by any sample indices.

·

The long run

relationship analysis shows all the sample indices have the long run

relationship during the study period.

SUGGESTIONS

·

The investors can

invest in the crude oil price commodity as the mean return was high. However,

market information need to be considered before investing. Since, oil price had

its impact on exchange price the investors are suggested to carefully monitor

the oil price.

·

The investors are

advised to calculate the basis (oil price-real price) before investing to

ensure no losses are borne. The regulators must bring option contract in

foreign exchange market so that the investors can take advantage of long and

short positions.

CONCLUSION

The present study

analyse the stationary of crude oil prices and exchange rate there is no

stationary in the crude oil prices and exchange rate. The study found the role

of crude oil prices in the information and price discovery of US Dollar in the

Foreign Exchange Market. The study confirmed the presence of normality, stationary,

long run relationship, volatility and causal relationship. Since most of the

securities are showing causality either unilateral it appears that crude oil

price or exchange rate is an important and useful information about the foreign

exchange market.

REFERENCES

ARTICLES

·

Amano, Robert A., and Simon Van Nor den.(1998)”Exchange

rates and oil prices”. Review of

International Economics 6.4

(1998): 683-694.

·

Al-Ezzee, D. I. “Real influences of Real Exchange rate

and Oil price changes on the growth of real GDP: Case of Bahrain.” International

Conference on Management and Service Science. Vol. 8. 2011.

·

Bahmani?Oskooee, Mohsen, and Magda Kandil. “Exchange rate

fluctuations and output in oil-producing countries: the case of Iran.” IMF

Working Papers (2007): 32

·

Bénassy-Quéré, Agnès, Valérie Mignon, and Alexis Penot.

“China and the relationship between the oil price and the dollar.” Energy

Policy 35. (2007):

5795-5805.

·

Hamisu Sadi Ali. “Dynamic relationship of exchange rate and

crude oil price in south afirca:are there asymmetries”. Research Journal of

Financial and Accounting. Vol.6,(2015).

WEBSITES

·

www.investing.com/crude oil price index

·

www.investopedia.com

·

www.forex market/definition.