Empirical Results

This section analyses the results of the testing procedures discussed in the previous section. Basically,
this research adopts the data from World Bank files for Malaysia and case study period from 1983 –
2013. The main purpose in this study tries to find the effect of macroeconomics variables which are
exports, imports, inflation and interest rate on exchange rate. The results from the regression model will
be present in this section. Firstly, I will present the results for unit root test, followed by cointegration
test, Vector Error Correction Model (VECM) and variance decomposition tests. Lastly, I will present the
result from the impulse response function by graphical table.

Level 1st Difference

No Trend Trend No Trend Trend
Lex 1.136217 -2.126680 -4.017582*** -4.086655***
Lim 1.085269 -2.072294 -4.186208*** -4.157849**
Linf -3.131997** -2.999491 -2.999491*** -6.864448***
Lir -1.150894 -3.230449* -4.930419*** -4.974731***

Unit Root Test

Table 1

Table 1 shows that, all the variables in stage level for trend and no trend do not reject unit root
test except Linf in no trend and Lir in trend. This is because, the p-value of Lex, Lim, Linf for trend and
Lir for no trend have more than 10% at significant level. So, all the variables other than Linf in no trend
and Lir in trend in the level stage for trend and no trend is non-stationary existence. The results in the
unit root test in first difference for no trend have showed that all the variables has a p-value at 1%
significant level. While, first difference with trend result showed that all the variables do reject the unit
root test. This is because, the p-value of all variables is in between 5% and 10% at significant level.

Augmented Dickey and Fuller test (ADF) is a test for a unit root for time series sample of data.
In Dickey-Fuller test, the larger the data been taken, the more complicated to run the data set in time
series models. If there a negative results from the data in unit root test, there are higher rate of rejection
of the hypothesis at level of confidence. In this research, unit root test is use to distinguish whether the
data have stationary or not.
Cointgeration test

Table 2: Unrestricted Cointegration Rank Test (Trace)

Hypothesized Trace 0.05
No. of CE(s) Eigenvalue Statistic Critical Value Prob.**

None * 0.660428 63.04628 60.06141 0.0274

At most 1 0.477959 31.72432 40.17493 0.271
At most 2 0.235071 12.87406 24.27596 0.6323
At most 3 0.151033 5.102866 12.3209 0.5533
At most 4 0.012151 0.354546 4.129906 0.6144

Trace test indicates 1 cointegrating eqn(s) at the 0.05 level

* denotes rejection of the hypothesis at the 0.05 level

Table 3:Unrestricted Cointegration Rank Test (Maximum Eigenvalue)

Hypothesized Max-Eigen 0.05
No. of CE(s) Eigenvalue Statistic Critical Value Prob.**

None * 0.660428 31.32197 30.43961 0.0387

At most 1 0.477959 18.85026 24.15921 0.2226
At most 2 0.235071 7.771195 17.7973 0.7311
At most 3 0.151033 4.74832 11.2248 0.5135
At most 4 0.012151 0.354546 4.129906 0.6144

Max-eigenvalue test indicates 1 cointegrating eqn(s) at the 0.05 level

* denotes rejection of the hypothesis at the 0.05 level

As the results, table 2 shows co integrating test has conducted to examine if variables have long term
equilibrium relationship. This study adopted Johansen test, where the results are indicate that there is
one co integrating vector present in traced. The max-eigenvalue test on table 3 also indicates
cointegration vector at the 5% level. In this case, the trace test has been chosen which is stated that
the series are cointegrated. That’s means, null hypothesis has been rejected. Therefore, all variables
have long term equilibrium relationship.
Vector Error Correction Estimates

Table 4

Vector Error Correction Estimates

Sample (adjusted): 1986 2013
Included observations: 28 after adjustments
Standard errors in ( ) & t-statistics in [ ]
Error D(LER) D(LEX) D(LIM) D(LINF) D(LIR)
Correction:
CointEq1 0.022168 -0.08405 -0.03004 -0.12681 -0.13077
-0.0429 -0.05334 -0.06604 -0.26101 -0.04946

D(LER(-1)) 0.123865 -0.33658 -0.37838 -0.98692 0.294333

-0.37244 -0.46309 -0.5734 -2.2662 -0.42941

D(LEX(-1)) 0.326374 -0.15549 0.31975 0.028573 0.535296

-0.30733 -0.38214 -0.47317 -1.87005 -0.35434

D(LIM(-1)) -0.26169 -0.04737 -0.39659 -0.62134 -0.03645

-0.32451 -0.40349 -0.49961 -1.97455 -0.37414

D(LINF(-1)) 0.014395 0.066664 0.044207 -0.34275 0.065364

-0.03844 -0.04779 -0.05918 -0.23388 -0.04432

D(LIR(-1)) 0.157581 -0.21716 -0.50558 0.270132 0.336768

-0.20221 -0.25142 -0.31132 -1.23038 -0.23314

C 0.008556 0.100033 0.09409 -0.11297 -0.13993

-0.0613 -0.07622 -0.09438 -0.373 -0.07068

From the result of VECM all independent variables are not significant at 5 % significant level except for
the LINF which is for inflation. There is a positive relationship between inflation and exchange rate at 5
% significant level. Inflation p-value is 0.03844 which is significant at 5 % level. A decrease of 1% of
inflation will increase the exchange rate of 1.4395 %. The inflation is the biggest dominant variable in
this test. The change of inflation also change can affect the other variables like export and interest rate.
Inflation is the variable that strongly affects the exchange rate in the short-run.
Impulse Response

Figure 1: Responses exports, imports, inflation and interest rate on exchange rate.

In order to examine the short-run dynamic effect of exports, imports, inflation and interest rate on
exchange rate in India, an impulse responses function is used to forecast outcome. The results of
exports, imports, inflation and interest rate, show at figure 1.

From the results, the impulse response analysis implies that the exchange rate of India has respond
immediately to the changes of the export. The response of exchange rate to export changes started
from first year and end at fifth year. For import, the response of import on exchange rate started on the
first year and end at the third year and going consistent for the future year. For inflation, the response of
inflation on exchange rate started on the first year and keep increase until the future year. For interest
rate, the response on exchange rate started on the first year and until the second year. After that it
keeps decrease until the future year.
Variance Decomposition of LER:

Table 5

Variance Decomposition of LER:

Period S.E. LER LEX LIM LINF LIR

1 100 0 0 0 0
2 0.127538 98.10641 0.615805 0.001207 0.297061 0.979517
3 0.176467 97.68966 0.429643 0.648857 0.169697 1.062143
4 0.223668 97.57018 0.596083 0.698821 0.351884 0.783032
5 0.273557 96.48309 1.330829 1.313954 0.346116 0.52601
6 0.318893 95.10774 2.073608 2.147053 0.277828 0.393769
7 0.363279 94.02634 2.56508 2.874897 0.214119 0.319567
8 0.404672 93.32915 2.807174 3.414735 0.174675 0.274264
9 0.443791 92.73634 2.965521 3.892998 0.159928 0.245213
10 0.480209 92.33549 3.03611 4.24568 0.158769 0.22395
Average 0.281207 95.73844 1.641985 1.92382 0.215008 0.480747

From the Table 5 the result show of the decomposition of forecast error variances of exchange rate
exports, imports, inflation and interest for the entire sample period. The variance decomposition test is
used to observe how much of the variance in one variable can be attributed to innovation in another
variable. The numbers on each row for each periods in the Table 5 show the percentages of forecast
variances exports, imports, inflation and interest rate on exchange rate.

The explanatory power of Import on exchange rate is 1.9% higher than the explanatory power of export
(1.6%), Inflation rate (0.2%) and interest rate (0.4%) on the average result. The strong explanatory
power of import has sent shock waves throughout India in which the import has the highest effect on
the exchange rate in the long-run.