imports function in the philippine economyy

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I n P a r t i a l F u l f i l l m e n t o f t h e R e q u i r e m e n t s f o r t h e c o u r s e E C O N M E T 1

Imports Function of the

Philippine EconomyKathleen Chiloe Cerrafon V25Submitted to Dr. Cesar Rufino

Aprill 13



Imports Function in the Philippine Economy

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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 ................................................................................................................... 6Exchange 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




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INTRODUCTION

Background of the StudyOpen 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 isn’t 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 isn’t 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 don’t have the resources to make them ourselves.

(EconomyWatch Content, 2010)




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Statement of the ProblemOur 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 aren’t 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 consumer’s 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 StudyThe objective of this paper is to:

i. To construct an econometric model that portrays the relationship of different

variables towards the country’s imports market.

ii. To determine whether the exchange rate, inflation rate, interest rate and the

country’s domestic income are significant measures that influences the

Filipino’s import demand.

iii. To prove Macroeconomic theories regarding trade markets learned in a

similar course.




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Significance of the StudyThis 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 LimitationsThe 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 model’s 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 wouldn’t do much justice as I won’t be able to explain it

further.




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Review of Related Literature

InflationThere 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 open-

economy countries will always have the need to import essential goods (such as rice for

the Philippines) as they alone couldn’t 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 it’s ability to produce or capital or labor effectiveness, but actually the




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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 RateExchange 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

won’t 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




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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 RateThe effect of Interest rate towards a country import demand is directed towards

the economy’s 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)




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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




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imports

The Imports variable is a quantitative

variable pertaining to the amount of

imports that entered the Philippine market.

intrate

The Interest Rate is an independent

variable that refers to the savings/deposit

interest rates provided by the Central

Bank. This is the annual return of the

deposit

infl

The Inflation Rate is an independent

variable that shows average rate of price

inflation throughout the year.

dominc

This is the annual domestic income of the

country. Also, this is an independent

variable.

excrate

This independent variable pertains to the

average exchange rate for the duration of

the year.




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b) Assumptions towards the given variables

Exogenous

Variable/

IndependentVariable

Expected

Effect on

Imports

Explanation




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Interest Rate Negative

Interest rates are consumer’s 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

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.

Inflation

(domestic)Positive

Domestic inflation means an increase in prices of

products manufactured in the Philippines. This

increase is a disincentive for consumers to buy

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.

Domestic

IncomePositve

Income serves as a consumer’s purchasing

power, hence the more income he has, he will

have more confidence into buying items.




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Exchange Rate Negative

The price of imported products relies heavily on

the exchange rate. The higher the prevailing

exchange rate is, the more expensive foreign

products are.

Hypothesized Economic ModelThe 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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Methodology

Dataa. 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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b. There are 14 observations in the data, running from 1997 till 2011. It is a

time-series data with annual observations.

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

software Gretl.

Empirical Results and Interpretation

dominc excrate imports intrate infl

1997 311.363 29.4707 38.581 9.1 5.8481998 325.451 40.8931 31.530 11.0 9.7031999 338.518 39.0890 32.568 7.3 6.3912000 358.071 44.1938 33.807 7.4 3.9682001 365.806 50.9927 34.939 7.5 6.8342002 381.621 51.6036 41.092 4.2 2.9692003 402.209 54.2033 42.576 4.2 3.4502004 425.239 56.0399 46.102 4.3 5.9762005 440.423 55.0855 49.487 3.8 7.626

2006 461.164 51.3143 54.078 3.5 6.2442007 488.403 46.1484 57.996 2.2 2.8102008 505.011 44.4746 60.420 2.2 9.2992009 518.610 47.6372 45.878 2.1 3.2492010 555.688 45.1097 58.229 1.6 3.829




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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 t-ratio p-value

const 56.6789 22.7197 2.4947 0.03416 **

dominc 0.0265488 0.0350337 0.7578 0.46794

excrate -0.305694 0.150578 -2.0301 0.07292 *

intrate -3.12429 0.838383 -3.7266 0.00472 ***

infl 1.25709 0.38213 3.2897 0.00938 ***

Mean dependent var 44.80593 S.D. dependent var 10.04044

Sum squared resid 166.1297 S.E. of regression 4.296377

R-squared 0.873235 Adjusted R-squared 0.816895

F(4, 9) 140.7890 P-value(F) 4.17e-08

Log-likelihood -37.18112 Akaike criterion 84.36224

Schwarz criterion 87.55753 Hannan-Quinn 84.06646

rho 0.143599 Durbin-Watson 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 R-

Squared 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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Explanation of Coefficientsa. 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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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. It’s 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. It’s 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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Frequency distribution for uhat3, obs 1-14

number of bins = 5, mean = -7.61296e-16, sd = 4.29638

interval midpt frequency rel. cum.

< -5.8641 -7.5302 2 14.29% 14.29% *****

Test for the Normality of the Stochastic Random Variable




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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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Variance Inflation Factors

Minimum possible value = 1.0

Values > 10.0 may indicate a collinearity problem

dominc 8.505

excrate 1.554

intrate 11.366

infl 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

Test for Multicollinearity

Correlation coefficients, using the observations 1997 - 2010

5% critical value (two-tailed) = 0.5324 for n = 14

dominc excrate imports intrate infl

1.0000 0.3706 0.8863 -0.9181 -0.2536 dominc

1.0000 0.2748 -0.5137 -0.1689 excrate

1.0000 -0.8630 -0.1164 imports

1.0000 0.4263 intrate

1.0000 infl




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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 HeteroscedasticityHeteroscedasticity 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 Park’s Test,

Koenker Test, White’s Test, Goldfeld-Quand Test and the Breusch- Pagan Test. This

paper has decided to use both the White’s Test and the Breusch-Pagan Test to




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diagnose heteroscedasticity.

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

White's test for heteroskedasticity

OLS, using observations 1997-2010 (T = 14)

Dependent variable: uhat^2

coefficient std. error t-ratio p-value

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

const -657.165 608.268 -1.080 0.3293

dominc 2.65977 2.76248 0.9628 0.3799

excrate 12.8373 14.8429 0.8649 0.4266

intrate -51.5978 57.5876 -0.8960 0.4113

infl 46.5927 45.2047 1.031 0.3499

sq_dominc -0.00350491 0.00302260 -1.160 0.2986

sq_excrate -0.169486 0.162427 -1.043 0.3445

sq_intrate 3.54682 3.67407 0.9654 0.3787

sq_infl -4.16107 3.74810 -1.110 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




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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.

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 time-

series, we can say that the odds of it having the violation are slim.

Test for MisspecificationIn order to diagnose if there is specification bias in the model, Ramsey’s RESET testwas used.

Breusch-Pagan test for heteroskedasticityOLS, 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 0.5787dominc 0.00225778 0.0167463 0.1348 0.8957excrate -0.0981364 0.0766878 -1.280 0.2327intrate -0.107174 0.513110 -0.2089 0.8392infl -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




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The table shows the result generated by the Ramsay’s 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.

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 (squaresonly)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




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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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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

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interest-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

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we can do, and What's next. Retrieved April 8, 2012, from Bangko Sentral ng Pilipinas:

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exports-imports-a30367

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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

imports function in the philippine economyy

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