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Imports Function of the Philippine Economy

Kathleen Chiloe Cerrafon V25
Submitted to Dr. Cesar Rufino

In Partial Fulfillment of the Requirements for the course ECONMET1

Imports Function in the Philippine Economy

Table of Contents
Introduction Background of the Study ....................................................................................................... 3 Statement of the Problem ..................................................................................................... 4 Objective of the Study ........................................................................................................... 4 Significance of the Study........................................................................................................ 5 Scope and Limitations............................................................................................................ 5 Review of Related Literature Inflation ................................................................................................................................ 6 Domestic Income ................................................................................................................... 6 Exchange Rate ....................................................................................................................... 7 Interest Rate ......................................................................................................................... 8 Operational Framework Description of the Variables Used .......................................................................................... 9 Assumptions towards the given variables ............................................................................ 11 Hypothesized Economic Model ............................................................................................ 13 Methodology Data .................................................................................................................................... 14 Empirical Results and Interpretation Estimated Values of OLS Regression..................................................................................... 16 Explanation of Coefficients .................................................................................................. 17 Tests for CLRM Violations Test for the Normality of the Stochastic Random Variable ................................................... 19 Test for Multicollinearity ..................................................................................................... 21 Test for Heteroscedasticity .................................................................................................. 22 Test for Misspecification ...................................................................................................... 24

Imports Function in the Philippine Economy

INTRODUCTION

Background of the Study

Open economies are directly connected through their trade markets. And since not one country is capable of feeding of all its necessities, the need for importing and exporting becomes more significant. Philippines, being the small country that it is, has quite put a dependence towards imports. Yes, we have colonialism ideologies running through our society and this gives Filipinos the constant cravings towards foreign products, but that itself isnt the sole reason why we participate in importing. We take in imports because we need it, we all do.

For example, rice, one of the essentials in a Filipino dining table, is known to be one of our largest imports and this is because the demand for this commodity is high while our capability to supply is isnt matching up. Another example of import, would be technological advancements and this so happens to be the largest items that our country ships in. Our imports for these products are high because, yet again, we are a developing country and we still dont have the resources to make them ourselves. (EconomyWatch Content, 2010)

Imports Function in the Philippine Economy

Statement of the Problem

Our imports are not solely dependent on the cravings of consumers. We are rational individuals hence we take into consideration different factors before we buy foreign products. Although as consumers, we arent fully mindful of these said factors and we just continue to buy only basing our judgments towards the prices. Not many of us know that our actions towards imports are also affected by other elements not directly susceptible to the consumers normal thinking. This gives us the chance to prove that they exist. This paper would like to answer the argument whether exchange rates, inflation rates, interest rates and the domestic income has an expansive effect towards our import demand.

Objective of the Study

The objective of this paper is to: i. To construct an econometric model that portrays the relationship of different variables towards the countrys imports market. ii. To determine whether the exchange rate, inflation rate, interest rate and the countrys domestic income are significant measures that influences the Filipinos import demand. iii. To prove Macroeconomic theories regarding trade markets learned in a similar course.

Imports Function in the Philippine Economy

Significance of the Study

This study can be of benefit to determine the inflow of imports in our country. The model generated in this paper can be used to forecast movements in the trade market once a change in the independent variables becomes significant. Stabilizing the net exports of a country

Scope and Limitations

The data used for this study is from the Asian Development Bank (Annual Reports), Bangko Sentral ng Pilipinas and National Statistics Office. The scope of this research is to prove the effects of inflation rate, interest rate, exchange rate and domestic income on the imports of the Philippines. I only limited the models exogenous variables to these four because theory-wise, I am only equipped with knowledge about imports based on these said variables. I may be able to prove relationships of imports with other economic indicators such as labor, reserves, or expenditures, but I wouldnt do much justice as I wont be able to explain it further.

Imports Function in the Philippine Economy

Review of Related Literature

Inflation
There are different implications of a high inflation rate. An article from Economic Times stated that expensive borrowing, decline in stock markets, and of course, even the inelastic goods (necessities) are to be affected (Agarwal, 2009). This indication meant a no-escape effect towards imports because no man is an island and openeconomy countries will always have the need to import essential goods (such as rice for the Philippines) as they alone couldnt be always able to meet the demands of the people (Workman, 2007).

Domestic Income
According to Shostak, GDP is a statistic that shows that what powers an economy is not its ability to produce or capital or labor effectiveness, but actually the

Imports Function in the Philippine Economy

consumption of the goods manufactured by the said function (Shostak, 2001). The demand for final goods and services is the ones taken into account. Domestic income is the measure of the cost incurred and the income received from the production process in the economy. Domestic income and GDP, in theory, are deemed to be equal and assuming that it is, we can suppose that consumers fully utilize their income on either consumption or savings (Bureau of Economic Analysis). With these theories, we can say that whenever domestic income rises, consumers will have more money to utilize hence a bigger consumption

Exchange Rate
Exchange Rate has a big role on the goods market of an economy. For trading, it serves as a link between domestic or foreign transactions because without it, both areas wont have any basis with regards to prices. ER movements, whether depreciation or appreciation, can affect the inflation and expected prices of domestic products. In the Philippines, peso has been appreciating slowly and this is due to continuous inflow of foreign direct investments, the decline of the USD due to the bearish movements of the US economy and of course, due to sustained overseas Filipino remittances. This exchange rate appreciation meant good for the import side of our foreign trading. (Bangko Sentral ng Pilipinas)

On another note, there has been an issue concerning the lag effect of exchange rate towards import prices. To think that exchange rates change by the second while prices are sometimes a bit inelastic, there has to be some sort disconnection towards 7

Imports Function in the Philippine Economy

the two. This was a crucial point for the trade market in the USA because if the exchange rates are fully reflected on their import prices, this would result in increased costs (higher exchange rate) or increase competitiveness (decrease in the value of dollar) by the domestic producers relative to foreign suppliers. They pointed out that this might be due to pricing-to-market, dollar invoicing, or global sourcing (Jabara, 2009). This can be used to explain some of the inconsistencies regarding exchange rate movements and the demand for imports.

Interest Rate
The effect of Interest rate towards a country import demand is directed towards the economys money market. It serves as an incentive for people to save their money to a deposit account rather than to consume. Although this affects the goods market as a whole, it is safe to assume that (Effects of Rising Interest Rates in UK)

Imports Function in the Philippine Economy

Operational Framework

Description of the Variables Used

This table explains the different variables, both dependent and independent, present in the model. The independent variables are the one

exogenous of the model, they are not affected, whatsoever, by forces within the equation. In this study, there are 4 independent variables and Imports, the dependent variable, is conditional to these 4.

Variable

Definition

Imports Function in the Philippine Economy

The Imports variable is a quantitative imports variable pertaining to the amount of imports that entered the Philippine market.

The Interest Rate is an independent variable that refers to the savings/deposit intrate interest rates provided by the Central Bank. This is the annual return of the deposit

The Inflation Rate is an independent infl variable that shows average rate of price inflation throughout the year.

This is the annual domestic income of the dominc country. Also, this is an independent variable. This independent variable pertains to the excrate average exchange rate for the duration of the year.

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Imports Function in the Philippine Economy

b) Assumptions towards the given variables

Exogenous Variable/ Independent Variable Expected Effect on Imports

Explanation

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Imports Function in the Philippine Economy

Interest rates are consumers basis on incentive. If ever the rates are high, the draw to save would also be high because this would mean a bigger return than usual. And since consumers only allot their income towards consumption and savings, if Interest Rate Negative they intend to increase the amount they save, they would have to find a way to decrease their consumption. And a decrease in consumption would mean a decrease in demand for goods, may it be domestic goods or imported products.

Domestic inflation means an increase in prices of products manufactured in the Philippines. This Inflation Positive (domestic) local items and if this happens, they have nothing else to turn to but to imports. Hence, the positive a-priori expectation between the two. increase is a disincentive for consumers to buy

Income serves as a consumers purchasing Domestic Positve Income have more confidence into buying items. power, hence the more income he has, he will

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Imports Function in the Philippine Economy

The price of imported products relies heavily on the exchange rate. The higher the prevailing Exchange Rate Negative exchange rate is, the more expensive foreign products are.

Hypothesized Economic Model

The model that this research used is a Linear-linear model. The null and alternative hypothesis for the regression analysis are as follows: Interest Rate : Domestic Inflation Rate Domestic Income Exchange Rate

The Estimated Econometric Model is:

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Imports Function in the Philippine Economy

Methodology
Data
a. The data gathered was that of the Philippines alone. We are only interested in the movements of imports in the country.

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Imports Function in the Philippine Economy

b.

There are 14 observations in the data, running from 1997 till 2011. It is a time-series data with annual observations. dominc 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 311.363 325.451 338.518 358.071 365.806 381.621 402.209 425.239 440.423 461.164 488.403 505.011 518.610 555.688 excrate 29.4707 40.8931 39.0890 44.1938 50.9927 51.6036 54.2033 56.0399 55.0855 51.3143 46.1484 44.4746 47.6372 45.1097 imports 38.581 31.530 32.568 33.807 34.939 41.092 42.576 46.102 49.487 54.078 57.996 60.420 45.878 58.229 intrate 9.1 11.0 7.3 7.4 7.5 4.2 4.2 4.3 3.8 3.5 2.2 2.2 2.1 1.6 infl 5.848 9.703 6.391 3.968 6.834 2.969 3.450 5.976 7.626 6.244 2.810 9.299 3.249 3.829

c. The data are analyzed, regressed and tested through the help of the software Gretl.

Empirical Results and Interpretation

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Imports Function in the Philippine Economy

Estimated Values of OLS Regression

Model 3: OLS, using observations 1997-2010 (T = 14) Dependent variable: imports HAC standard errors, bandwidth 1 (Bartlett kernel) Coefficient Std. Error const dominc excrate intrate infl Mean dependent var Sum squared resid R-squared F(4, 9) Log-likelihood Schwarz criterion rho 56.6789 0.0265488 -0.305694 -3.12429 1.25709 22.7197 0.0350337 0.150578 0.838383 0.38213 t-ratio 2.4947 0.7578 -2.0301 -3.7266 3.2897 p-value 0.03416 0.46794 0.07292 0.00472 0.00938 * *** *** **

44.80593 166.1297 0.873235 140.7890 -37.18112 87.55753 0.143599

S.D. dependent var S.E. of regression Adjusted R-squared P-value(F) Akaike criterion Hannan-Quinn Durbin-Watson

10.04044 4.296377 0.816895 4.17e-08 84.36224 84.06646 1.626746

This table was generated after I have done regression, through GRETL, on Imports with the different exogenous variables I have mentioned earlier. The R-Squared for this regression is 0.873235, signifying that 87.32% of the variation in imports is explained by the given exogenous variables. We can assume that the RSquared is a goodness-of-fit because more than half of the information by the endogenous variable can be justified by the exogenous variables. Hence, the sample regression line fits the data quite well.

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Imports Function in the Philippine Economy

Explanation of Coefficients
a. Inflation Rate i. The inflation rate has a coefficient value of 1.25709. ii. This positive value satisfies the a-priori assumption that inflation rate has a positive relationship with imports. iii. It suggests that when inflation rate rises, the amount of imports rises by 1.25709. iv. This variable has a p-value of 0.009 which is less than 0.05 so we can assume that inflation rate is significant. b. Interest Rate i. Interest rate has a coefficient value of -3.12429. ii. The negative value satisfies the a-priori expectation that interest rate has a negative effect on imports. iii. This means that when interest rate increases, the amount of imports would decrease by 3.12429. iv. The coefficient has a p-value of 0.00472, and since it is less the 0.05, it is deemed significant. c. Exchange Rate i. Exchange rate has a coefficient value of -0.305694. ii. It being a negative coefficient satisfies the a-priori expectation that exchange rate has a negative relationship with imports. iii. It means that when exchange rate increases, the amount of exports will fall by 0.305694.

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Imports Function in the Philippine Economy

iv. The coefficient has a p-value of 0.07 which is greater than 0.05 and this made the variable insignificant. d. Domestic Income i. Domestic Income has a coefficient value of 0.0265488 ii. Its positive value satisfies the hypothesized relationship with imports which is positive. iii. This means that when domestic income increase, imports will increase by 0.0265488 iv. The coefficient has a p-value of 0.4 which deemed it insignificant. e. Intercept i. The constant coefficient has a value of 56.6789 ii. It means that if the economy has no inflation, a zero interest rate and exchange rate and no domestic income, it will still accumulate 56.6789 worth of imports. iii. Its p-value is 0.03 and because it is less than 0.05, it assumed that the intercept is significant. Model: ( ( ) ) ( ) ( )

Tests for Classical Linear Regression Model Violations

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Imports Function in the Philippine Economy

Test for the Normality of the Stochastic Random Variable

Frequency distribution for uhat3, obs 1-14 number of bins = 5, mean = -7.61296e-16, sd = 4.29638 interval < -5.8641 midpt -7.5302

19 frequency
2

rel. 14.29%

cum. 14.29% *****

Imports Function in the Philippine Economy

Testing for the normality of the stochastic random variable simply means checking whether the error terms per variable follows a normal distribution as a whole. The null hypothesis is that the error terms follow the normality distribution assumption while the alternative hypothesis is that the normality distribution assumption does not apply (Gujarati, 2003). This test will be based on the p-value. If it is greater than the 5% level of significance then the null hypothesis is to be accepted and we can assume that stochastic variables have a normal distribution. On the other hand, if the p-value will be less than the 5% level of significance, the null hypothesis will have to be rejected and the alternative hypothesis will apply. According to the table generated by GRETL, the p-value is 0.28991. And since 0.28991>0.05, the null hypothesis should be accepted and it is now safe to assume that the stochastic random does indeed follow a normal distribution.

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Imports Function in the Philippine Economy

Test for Multicollinearity

Variance Inflation Factors Minimum possible value = 1.0 Values > 10.0 may indicate a collinearity problem dominc excrate intrate infl 8.505 1.554 11.366 1.496

VIF(j) = 1/(1 - R(j)^2), where R(j) is the multiple correlation coefficient between variable j and the other independent variables Properties of matrix X'X: 1-norm = 2888874.7 Determinant = 3.9726487e+11 Reciprocal condition number = 7.1448011e-09

Correlation coefficients, using the observations 1997 - 2010 5% critical value (two-tailed) = 0.5324 for n = 14 dominc 1.0000 excrate 0.3706 1.0000 imports 0.8863 0.2748 1.0000 intrate -0.9181 -0.5137 -0.8630 1.0000 infl -0.2536 -0.1689 -0.1164 0.4263 1.0000 dominc excrate imports intrate infl

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Imports Function in the Philippine Economy

Multicollinearity is the presence of correlation between variables. One of the several ways to diagnose the existence of this violation in a model is the use of the VIF criterion or the Variance Inflation Factor. The VIF tests the severity of multicollinearity of variables in the model. The imports function model is tested for multicollinearity using the VIF Criterion and the results are shown by the two tables above. The fact that all of the independent variables dominc, excrate, intrate and infl have VIF values that are less than 10 means that there exists a tolerable multicollinearity in the model. Another way to test this is thru the correlation coefficient shown by the second table. The value of the correlation coefficient ranges from -1 to 1 and the closer the value of 2 variables to 1, the stronger their relationship is with each other. In the generated table, no 2 variables correlation coefficient is equal to one, although some are almost approaching it which meant that multicollinearity exits but it remains tolerable.

Test for Heteroscedasticity

Heteroscedasticity is present whenever the critical assumption that the variances of the error terms must be constant is violated. There are several ways to detect heteroscedasticity in a model such as Parks Test, Koenker Test, Whites Test, Goldfeld-Quand Test and the Breusch- Pagan Test. This paper has decided to use both the Whites Test and the Breusch-Pagan Test to

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Imports Function in the Philippine Economy

diagnose heteroscedasticity.

White's test for heteroskedasticity OLS, using observations 1997-2010 (T = 14) Dependent variable: uhat^2 coefficient const dominc excrate intrate infl sq_dominc sq_excrate sq_intrate sq_infl -657.165 2.65977 12.8373 -51.5978 46.5927 -0.00350491 -0.169486 3.54682 -4.16107 std. error 608.268 2.76248 14.8429 57.5876 45.2047 0.00302260 0.162427 3.67407 3.74810 t-ratio -1.080 0.9628 0.8649 -0.8960 1.031 -1.160 -1.043 0.9654 -1.110 p-value 0.3293 0.3799 0.4266 0.4113 0.3499 0.2986 0.3445 0.3787 0.3174

-------------------------------------------------------------

Warning: data matrix close to singularity! Unadjusted R-squared = 0.499096 Test statistic: TR^2 = 6.987347, with p-value = P(Chi-square(8) > 6.987347) = 0.537998

This table is generated by Gretl after performing the Whites Test. According to it, the p-

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Imports Function in the Philippine Economy

value is 0.537998 since it is less than 0.05, there is strong evidence that the null hypothesis is to be accepted so we can assume that heteroscedasticity is not present in this model.

Breusch-Pagan test for heteroskedasticity OLS, using observations 1997-2010 (T = 14) Dependent variable: scaled uhat^2 coefficient std. error t-ratio p-value ------------------------------------------------------const 6.25723 10.8619 0.5761 0.5787 dominc 0.00225778 0.0167463 0.1348 0.8957 excrate -0.0981364 0.0766878 -1.280 0.2327 intrate -0.107174 0.513110 -0.2089 0.8392 infl -0.190852 0.237959 -0.8020 0.4432 Explained sum of squares = 8.50814 Test statistic: LM = 4.254069, with p-value = P(Chi-square(4) > 4.254069) = 0.372712

Another test we used is the Breusch-Pagan test. The p-value generated is 0.372712 is less than the 0.05 level of significance. Thus, the null hypothesis is again accepted and heteroscedasticity is not evident in the model. A possibility on why this violation is not present in the model is because heteroscedasticity is common with cross-section data and since the model is a timeseries, we can say that the odds of it having the violation are slim.

Test for Misspecification

In order to diagnose if there is specification bias in the model, Ramseys RESET test was used.

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Imports Function in the Philippine Economy

RESET test for specification (squares and cubes) Test statistic: F = 0.503488, with p-value = P(F(2,7) > 0.503488) = 0.625 RESET test for specification (squares only) Test statistic: F = 0.010388, with p-value = P(F(1,8) > 0.0103883) = 0.921 RESET test for specification (cubes only) Test statistic: F = 0.027912, with p-value = P(F(1,8) > 0.0279116) = 0.871

The table shows the result generated by the Ramsays RESET Test. The null hypothesis here is that the model is correctly specified while the alternative hypothesis states otherwise and that there is indeed a misspecification bias. The p-values of all tests are more than the 0.05 level of confidence, we can accept the null hypothesis that there is no misspecification the model.

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Imports Function in the Philippine Economy

Conclusion
As for the model, I can conclude that it has not violated any CLRM assumptions, so I can assume that this is a fit econometric model for imports. ( ( ) ) ( ) ( )

However, I do believe that there are far more variables that is capable of affecting the import flow in the country. Only, in this model, I have used variables that are known to have direct effects. Now that we know the effects of interest rate, inflation rate, domestic income and exchange rate towards imports. We can further expound the model and come up with a more detailed one that can be used to forecast import inflow in the country.

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Imports Function in the Philippine Economy

Bibliography
EconomyWatch Content. (2010, March 10). Philippines Trade, Exports and Imports. Retrieved from Economy Watch: http://www.economywatch.com/world_economy/philippines/export-import.html Effects of Rising Interest Rates in UK. (n.d.). Retrieved from Economics Help: http://www.economicshelp.org/macroeconomics/monetary-policy/effect-raisinginterest-rates.html Jabara, C. L. (2009). How Do Exchange Rates Affect Import Prices? Recent Economic Literature and Data Analysis. Office of Industries Working Paper. Washington: U.S International Trade Commission. Bangko Sentral ng Pilipinas. (n.d.). Q&A on the Exchange Rate Impact: How much, What we can do, and What's next. Retrieved April 8, 2012, from Bangko Sentral ng Pilipinas: http://www.bsp.gov.ph/downloads/Publications/FAQs/fximpact.pdf Shostak, F. (2001, August 23). What is up with the GDP? Retrieved April 10, 2012, from Ludwig von Mises Institute: http://mises.org/daily/770 Agarwal, V. (2009, October 11). Implications of a rising inflation rate. Retrieved April 10, 2012, from The Economic Times: http://articles.economictimes.indiatimes.com/200910-11/news/27633192_1_inflation-rate-base-effect-soft-interest-rate Workman, D. (2007, September 5). Top Filipino Exports & Imports. Retrieved April 11, 2012, from International Trade: http://daniel-workman.suite101.com/top-filipinoexports-imports-a30367 Bureau of Economic Analysis. (n.d.). A Guide to the National Income and Product Accounts of the United States. Retrieved April 12, 2012, from Bureau of Economic Analysis: http://www.bea.gov/national/pdf/nipaguid.pdf 27

Imports Function in the Philippine Economy

Asian Development Bank. (2011, July 30). Key Indicators for Asia and the Pacific 2011. Retrieved April 11, 2012, from Asian Development Bank: http://www.adb.org/sites/default/files/pub/2011/Key-Indicators-2011.pdf

Philippine Imports. (2012, January 9). Retrieved from Index Mundi: http://www.indexmundi.com/philippines/imports.html

Data taken from: Asian Development Bank. (2011, July 30). Key Indicators for Asia and the Pacific 2011. Retrieved April 11, 2012, from Asian Development Bank: http://www.adb.org/sites/default/files/pub/2011/Key-Indicators-2011.pdf Philippine Imports. (2012, January 9). Retrieved from Index Mundi: http://www.indexmundi.com/philippines/imports.html

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