OIL PRICE FLUCTUATION AND ITS IMPACT ON FOREX
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.
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.
Oil Price, Oil Price Fluctuation, Foreign exchange Market.
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
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.
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
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.
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
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
OBJECTIVES OF THE STUDY
analyze the normality and stationarity of crude oil prices and exchange rate.
investigate the causality between crude oil prices and exchange rate data.
investigate the long-term relationship between crude oil prices and exchange
analyses the volatility of crude oil price and exchange rate.
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.
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
USED FOR THE STUDY
The tools to be used for the study is
ANALYSIS AND INTERPRETATION
3.1 Descriptive Statistics Result for the Crude Oil Prices and USD/INR Real
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.
3.2 Unit Root Test result for the Exchange Rate and Crude Oil Price for five
years from 2011 to 2015
Dickey-Fuller test statistic
Test critical values:
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.
3.3 Result of Co integration between Crude Oil Prices and Real Exchange Rate
No. of CE(s)
At most 1 *
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
the methods. If one moves to the next row, the test statistic of Max Eigen
Trace statistic (18.87166) against exceeds the critical value.
3.4 Granger Causality Test Result for the monthly Oil Price and Exchange Rate
Oil Return does not
Granger Cause Exchange Rate Return
Exchange Rate Return
does not Granger Cause Oil Return
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
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.
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.
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
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
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