Is energy consumption sensitive to foreign capital inflows and currency devaluation in Pakistan?

ABSTRACT

This study investigates the relationship between foreign capital inflows and energy consumption by incorporating economic growth, exports and currency devaluation in energy demand function for the case of Pakistan. The long-run and short-run effects are examined via ARDL bounds testing procedure. Foreign capital inflows and currency devaluation (economic growth and exports) decrease (increase) energy consumption in long-run. The results confirm a feedback effect between foreign capital inflows and energy consumption. These findings would be helpful to policy makers in designing comprehensive economic and energy policies for utilizing foreign capital inflows as a tool for optimal use of energy sources to enhance economic development in long run.

KEYWORDS:

• Energy consumption
• foreign capital inflows
• ARDL
• Pakistan

JEL CLASSIFICATION:

• F21
• O13
• F18

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ Empirical findings reported by Zaman et al. (2012), Mudakkar et al. (2013) and Alam (2013) are conflicting as these studies ignored the potential role of devaluation and exports in determining energy consumption.

² We have adopted log-linear specification for empirical analysis due to its superiority.

³ The index of foreign capital inflows is generated by authors.

⁴ The quadratic match-sum approach is particularly important to avoid the small sample problem. Further, data transforming from low into high frequency is done while adjusting the seasonal variations. Cheng et al. (2012) highlighted that the seasonality problem can be avoided by using a quadratic match-sum approach as it reduces the point-to-point data variations. Hence, this method is preferred due to its convenient operating procedure.

⁵ Foreign direct investment affects energy consumption via income (scale) effect, technique effect, composite effect and comparative advantage effect; and wealth effect, i.e. stock market channel (Leitão 2015). Foreign remittances affect energy consumption via consumer effect, business effect and wealth effect. Consumer effect indicates that increasing income level of the households or consumers due to the emergence of remittances inflows will enable them to purchase consumer goods, such as automobiles, refrigerators, air conditioners and washing machines. Eventually, these durable and luxury items consume energy a lot and thereby adding more demand for total energy. Business effect reveals that increasing income of the business people due to the inflows of remittances will allow them to renew existing ventures or to create new business ventures. Creating new business ventures or expanding existing business ventures following the consumers’ demand for luxury items require usage of higher energy as energy is utilized as one of the potential inputs in the process of intermediate and final industrial production activities (Akçay and Demirtaş 2015). Wealth effect entails that stock market development plays a vital role and it has been attractive particularly for business firms of an economy. This is because wealth effect is the cause of stock market development that not only increases investors’ confidence but also motivates them to diversify their money from other traditional investment ventures to profit-making stock market activity. In this way, the capital gain received from domestic stock market investment and remittances inflows received from overseas induce them to expand their business activity as well as motivate them to buy luxurious items. In doing so, business firms may expand the economy and also require higher amounts of energy for business and consumption activities (Akçay and Demirtaş 2015).