Investment, exchange rates and relative prices evidence from emerging economies

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  • Glasgow Theses Service http://theses.gla.ac.uk/

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    Chavali, Aditya Sathyan (2014) Investment, exchange rates and relative prices: evidence from emerging economies. PhD thesis. http://theses.gla.ac.uk/5592/ Copyright and moral rights for this thesis are retained by the author A copy can be downloaded for personal non-commercial research or study, without prior permission or charge This thesis cannot be reproduced or quoted extensively from without first obtaining permission in writing from the Author The content must not be changed in any way or sold commercially in any format or medium without the formal permission of the Author When referring to this work, full bibliographic details including the author, title, awarding institution and date of the thesis must be given.

  • Investment, Exchange Rates and Relative Prices:

    Evidence from Emerging Economies

    Aditya Sathyan Chavali

    Submitted in fulfilment of the requirements for the degree of

    Doctor of Philosophy

    College of Social Sciences

    Business School

    Economics

    University of Glasgow

    2014

  • 1

    Thesis Abstract

    In open economies, external factors have an important effect on real and nominal

    macroeconomic variables, and hence on economic welfare. For example, external factors

    such as the degree of trade openness and the level and variability of the exchange rate are

    important for the determination of domestic investment and domestic prices. Several

    aspects of the external sector and their impact on the domestic economy form the main

    themes that are investigated in this thesis of four main empirical chapters. Firstly, we

    investigate the determinants of business investment for a panel of emerging economies.

    We take an open economy framework incorporating the exchange rate as an important

    factor in a simple stylised model. To test the model implications we utilise sectoral

    industry data and endeavour to take account of panel heterogeneity and endogeneity in our

    estimation. In the empirical section of this chapter a rise in the exchange rate, a domestic

    currency appreciation, was found to be positively related to investment for some of the

    countries. We posit that this is due to the importance of the cost channel for firms. In the

    next chapter, we examine the impact of exchange rate volatility on sectoral investment for

    emerging economies. Volatile exchange rates make investment decisions in open

    economies difficult due to uncertainty. Our approach is robust to four different measures of

    exchange rate volatility. The empirical results show that permanent exchange rate volatility

    measure has a strong positive impact on domestic investment in the long run, which could

    possibly imply investors in small open economies with better financial markets are able to

    diversify risks. Volatility may also be more important than the level of the exchange for

    investment. The next chapter in this Thesis on Open Emerging Market Economies

    considers the extent of exchange rate pass through to import prices. In a stylized model,

    import prices are dependent upon the exchange rate, marginal cost and the mark up. Our

    results show that the average response of import prices to movements in the exchange rate

    is negative and incomplete. However, once we take account of exchange rate asymmetry,

    important differences such as market share and mark-ups exist between Latin America and

    Asia. The fifth chapter, and final main empirical chapter, investigates whether increased

    trade openness dampens relative producer prices in a panel of Indian manufacturing sector.

    We purport that the import share, average labour productivity and the mark-up are the key

    determinants of sectoral wholesale relative producer prices. After accounting for

    endogeneity, our main result is that, there is some evidence that rise in import share

    decreases the relative producer prices, but only feebly influences the decline across the

    sectors in India.

  • 2

    Table of Contents

    Thesis Abstract ....................................................................................................................... 1

    Acknowledgement................................................................................................................ 10

    Chapter 1 .............................................................................................................................. 14

    General Introduction ............................................................................................................ 14

    1.1 Background and Motivation ........................................................................................... 14

    1.2 Research Objectives and Thesis Outline ........................................................................ 29

    Chapter 2 .............................................................................................................................. 33

    Investment and Exchange Rates: Panel Sectoral Evidence for Emerging Economies ........ 33

    Chapter Abstract................................................................................................................... 33

    2.1 Introduction .................................................................................................................... 34

    2.2 Literature Review ........................................................................................................... 36

    2.3 Theoretical Model .......................................................................................................... 39

    2.4 Data and Empirical Methodology .................................................................................. 45

    2.5 Econometric Framework ................................................................................................ 52

    2.5.1 Panel Unit Root Tests ................................................................................................. 52

    2.5.2 Pooled Mean Group Estimation .................................................................................. 53

    2.5.3 Dynamic Panel Data: Generalised Method of Moments (GMM)

    Estimation.....55

    2.5.4 Empirical Specification ............................................................................................... 56

    2.6 Results ............................................................................................................................ 57

    2.6.1 Panel Unit Root Tests ................................................................................................. 57

    2.6.2 PMGE Estimates ......................................................................................................... 58

    2.6.3 DPD-GMM Estimates ................................................................................................. 61

    2.6.4 DPD-GMM Estimates excluding disinvestment at levels. .......................................... 64

    2.6.5 DPD-GMM Estimates of Investment relationship including disinvestment............... 64

    2.7 Conclusions .................................................................................................................... 66

  • 3

    Chapter 3 .............................................................................................................................. 76

    Investment and Exchange Rate Volatility in Emerging Market Economies........................ 76

    Chapter Abstract...76

    3.1. Introduction ................................................................................................................... 77

    3.2 Literature Review ........................................................................................................... 79

    3.3. Data ............................................................................................................................... 82

    3.4 Econometric Methodology ............................................................................................. 85

    3.4.1 GARCH Volatility Measurement ................................................................................ 86

    3.4.2 Component GARCH (CGARCH) ............................................................................... 88

    3.4.3 Pooled Mean Group Estimation .................................................................................. 89

    3.4.4 Generalised Method of Moments (GMM) .........................90

    3.5 Results ............................................................................................................................ 92

    3.5.1 Panel Unit Root Tests ................................................................................................. 92

    3.5.2 PMGE Estimates of Investment and Exchange rate volatility .................................... 95

    3.5.3 DPD-GMM Estimation...97

    3.5.4 Investment and External Debt ..................................................................................... 99

    3.5.5 DPD-GMM Estimation ............................................................................................. 102

    3.6 Conclusion104

    Chapter 4 ............................................................................................................................ 119

    Exchange Rate Pass Through To Import Prices: Panel Evidence from Emerging Market

    Economies .......................................................................................................................... 119

    Chapter Abstract.................................................................................................................119

    4.1 Introduction .................................................................................................................. 120

    4.2 Literature Review ......................................................................................................... 121

    4.3 Theoretical Model ........................................................................................................ 127

    4.4 Data .............................................................................................................................. 129

    4.5 Econometric Methodology ........................................................................................... 135

  • 4

    4.5.1 Panel Unit Root Tests ............................................................................................... 135

    4.5.2 Pooled Mean Group Estimation....137

    4.5.3 Empirical Specification ............................................................................................. 138

    4.5.4 Exchange Rate Asymmetry ....................................................................................... 138

    4.6 Results .......................................................................................................................... 140

    4.6.1 Panel Unit Root Results ............................................................................................ 140

    4.6.2 Combined Panel PMGE Results ..............................................................................142

    4.6.3 Results for Latin America ....145

    4.6.4. Results for Asia ........................................................................................................ 146

    4.6.5 DPD-Generalized Method of Moments (GMM) Estimation .................................... 148

    4.7 Conclusions..151

    Chapter 5 ............................................................................................................................ 166

    Relative Producer Prices and Openness: A panel study of the Indian Manufacturing Sector

    ............................................................................................................................................ 166

    Chapter Abstract........................................................................................................ ...166

    5.1 Introduction .................................................................................................................. 167

    5.2 Literature Review ......................................................................................................... 169

    5.3 Data .............................................................................................................................. 172

    5.4 Econometric Methodology ........................................................................................... 176

    5.4.1 Fixed Effects and Random Effects ............................................................................ 177

    5.4.2 Pooled Mean Group Estimation ................................................................................ 178

    5.4.3 DPD - Generalised Method of Moments (GMM) ..................................................... 179

    5.4.4 Panel Unit Root Tests ............................................................................................... 179

    5.4.5 Empirical Specification ............................................................................................. 180

    5.5 Results .......................................................................................................................... 182

    5.5.1 Panel Unit Root Tests ............................................................................................... 182

    5.5.2 Panel Estimation PMGE Results ............................................................................ 183

  • 5

    5.5.3 Dynamic Panel Data Fixed Effects and Random Effects Estimation .................... 185

    5.5.4 Dynamic Panel Data Generalised Method of Moments (GMM) Estimation ......... 187

    5.6 Conclusions .................................................................................................................. 189

    Chapter 6 ............................................................................................................................ 202

    6.1 General Conclusions and Future Research Work ........................................................ 202

    6.2 Key findings and policy implications .......................................................................... 204

    6.3 Policy Implications.......................................................................................................206

    6.3 Future Research Work..207

  • 6

    List of Tables

    Table 1.1 Aggregate Macroeconomic Indicators ................................................................. 27

    Table 2.1 Summary Statistics ............................................................................................... 48

    Table 2.2 IPS and LLC Panel Unit Root tests..55

    Table 2.3 PMGE Estimates of Investment Relationship excluding disinvestment .............. 59

    Table 2.4 DPD-GMM: Investment Relationship excluding disinvestment ......................... 63

    Table 2.5 DPD-GMM: Investment Relationship exlcuding disinvestment at levels...........65

    Table 2.6 DPD-GMM: Including disinvesmtent at levels67

    Table 3.1 Panel Unit Root Tests ...........................................................................................

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