Crude oil prices and macroeconomic activities: a structural VAR approach to Indonesia

ABSTRACT

The effects of oil price fluctuations on growth, inflation, and exchange rates for Indonesia are investigated in the framework of the structural vector autoregressive (SVAR). To identify linking oil prices to the macroeconomic activities accurately, the entire sample period is separated into two sub-samples such as the era of net oil exporter (1998:M1-2003:M12) and the era of net oil importer (2004:M1-2019:M4). In the era of net oil exporter, we discover that a surge in oil prices promotes growth and contributes to appreciating the Indonesian currency. In the era of net oil importer, by contrast, an upsurge in oil prices reduces growth and causes a depreciation of the exchange rate. However, there is little evidence that an upswing in oil prices in both eras has a significantly detrimental effect on inflation.

KEYWORDS:

• Exchange rate
• growth
• Indonesia
• oil prices
• SVAR

JEL CLASSIFICATION:

• C32
• O53
• Q43

Disclosure statement

The authors declare that they have no conflict of interest.

Ethical approval

This article does not contain any studies with human participants performed by any of the authors.

Notes

¹ In addition, there has been an increasing body of literature that uncover that oil prices explain the significance of the variation in the balance of trade (e.g. Killian, Rubucci, and Spatafora 2009; Le and Chang 2013; Allegret et al., 2015; Rafiq, Sgro, and Apergis 2016; Baek, Ikponmwosa, and Choi 2019).

² The oil sector has been a crucial role in the Indonesian economy since the first oil discovery in North Sumatra in 1885. Between the early 1980s and the mid-1990s, for example, Indonesian oil production had averaged 1,454 thousand barrels per day (BPD), ranking as the worlds’ 15th biggest oil-producing country and accounting for about 3% of world production. Thus, the oil sector alone accounted for more than 40% of the Indonesian state and export revenues. Since the late 1990s, however, Indonesia had begun to face constrained oil production and expanded domestic consumption. Because of a lack of exploration and investment in the oil sector, for example, the production of crude oil fell from 1,472 thousand BPD in 1999 to 785 thousand BPD in 2015. Consequently, the oil sector’s contribution to state (exports) revenues decreased from nearly 22% (23%) in 1999 to about 5% (12%) in 2015. Due to an increase in demand for fuel led by economic growth, in contrast, Indonesia’s oil consumption increased by nearly 63% from 964 thousand BPD in 1999 to 1,570 thousand BPD in 2015. As a result, Indonesia’s OPEC membership is currently under suspension.

³ Basnet and Upadhyaya (2015) study the oil price influence on growth, inflation, and exchange rates in five ASEAN countries that include Indonesia using quarterly data from 1970 to 2012. In their assessments, however, the authors do not directly consider the two distinct episodes of Indonesia’s transition to a net exporter from an importer, thereby possibly providing misleading findings.

⁴ Short-run restrictions utilize estimates ${\Sigma }_{\text{u}}$ along with covariance restrictions in Equation (3)(3) ${\mathrm{u}}_{\mathrm{t}}={\mathrm{A}}_0^{-1}\mathrm{B}{\epsilon }_{\mathrm{t}}$(3) in estimating Christiano, Eichenbaum, and Vigfusson (2006) prove that when estimating SVAR, short-run restrictions generally perform better in comparison to long-run restrictions.

⁵ A lag length of three months (one month) for Case I (Case II) is chosen based on AIC.

⁶ This resulting phenomenon has come to be known as the revenue effect for a net oil exporter.

⁷ The author thanks the reviewer for raising this critical issue.

⁸ Data for January 2004 through April 2019 are taken from the Energy Information Administration (EIA) and International Financial Statistics (IFS). Additionally, using AIC a lag length of two months is chosen for all eight countries. Finally, all variables are first log-transformed.

⁹ Rahman and Serletis (2012) also detect the little connection between oil prices and growth in Canada. However, Lardic and Mignon (2006) reveal that Norway’s growth significantly responds to oil price movements.

¹⁰ It is worth noticing that in response to an increase in oil prices, inflation tends to rise less in Mexico and Russia that have price controls than in Canada and Norway that have no controls, meaning that gasoline price controls appear to influence inflation in emerging economies responding to a shock in oil prices. This contradicts with Escobar, Del Valle, and Vega (2019) who uncover that inflation increases more in economies with price controls than in economies with no controls.

¹¹ The results coincide with Chaudhuri and Danieal (1998) for Canada and Rautava (2004) for Russia. However, Akram (2004) and Mohammadi and Jahan-Parvar (2012) prove that higher oil prices contribute to the appreciation of the Norwegian Kroner and Mexican Peso, respectively.

¹² This is in line with a number of studies (e.g. Burbidge and Harrison 1984; Jimenez-Rodriguez and Sanchez 2005; Lardic and Mignon 2006; Zhang 2008). However, this result is at odds with other studies such as Gunado and de Gracia (2003) and Huang, Hwang, and Peng (2005).

¹³ Many studies validate the results. Some of the examples encompass Hooker (2002) and Barsky and Kilian (2004) for the USA, De Gregorio et al. (2007) for industrial and emerging countries, Kilian (2008) for the Group of Seven, Alvarez et al. (2011) for the EU nations.

¹⁴ This is consistent with Reboredo (2012) in that oil price-exchange rate dependence is generally weak in oil-importing advanced nations.

¹⁵ Tiwari, Dar, and Bhanja (2013) and Kisswani (2016) are among those studies supporting our findings.

¹⁶ Since Indonesia shifted to a freely floating exchange rate regime after the Asian financial crisis, we select January 1998 as the beginning date for the analysis.

Additional information

Funding

This research received no specific grant from any funding agency in the public, commercial, or not-for-profit sectors.