On the impact of kuna exchange rate
on Croatian foreign trade
results: Elasticity approach
Petar Sorić
Presentation structure
 Motivation and subject of research
 Data & econometric methods
 Theoretical background
 Related literature review
 Empirical models
 Econometric results and their implications
 Concluding remarks
Motivation and subject of research
Permanently
unfavourable
Croatian
foreign trade
results
The myth of
overvaluated
kuna exchange
rate
Need of more
detailed
foreign trade
exploring
Motivation and subject of research
Lde
Lita
6.10
Laut
Ltb
Series
means
are
adjusted
in order to
fit on the
graph
6.05
6.00
5.95
5.90
5.85
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
•TB reaches it’s low point in 1997, Q4; stagnation
from 2002
•rer’s follow the tb trend line until 2003, when they
diverge
Data & econometric methods
 Quarterly data, 1996Q1 to 2007Q4, seasonally
adjusted and in logarithms
o tb=ln(X)-ln(IM)
o rer data obtained by correcting nominal
exchange rate for the ratio of foreign and
domestic price level (CPI)
o rer increase=appreciation
 Johansen’s approach used in order to obtain both the
short run (VECM) and the long run elasticity
coefficients (cointegration vector)
J-curve analysis
Theoretical background
Marshall-Lerner
condition
ε
E
 ε
U
1
J-curve
Related literature review
 Turkalj (2005): small (but expected) estimated
imports and exports exchange rate elasticities (OLS)
 Mervar (2003): income effect dominates over the
exchange rate impact (PSS)
 Stučka (2003): Existence of the J-curve, estimated
long-run rer coefficient of 0.9-1.3% (ARDL, PSS,
Bewley ARDL)
Analysis results differ with respect to the used
method
Empirical models
 “Catch all” model
tb = f(gdp_cro, gdp_de, gdp_aut, gdp_ita, rer_de, rer_aut, rer_ita)
 Three disaggregated models (CRO vs.DE,
CRO vs. ITA and CRO vs. AUT)
tb = f(gdp_cro, gdp_de, rer_de)
tb = f(gdp_cro, gdp_ita, rer_ita)
tb = f(gdp_cro, gdp_aut, rer_aut)
“Catch all” model
Results of Johansen's cointegration test
rank
0
1
2
3
4
5
6
7
eigenvalue
0.86921
0.75404
0.65149
0.49563
0.34848
0.27234
0.17118
0.11469
trace
274.18
184.67
122.96
76.577
46.461
27.610
13.621
5.3601
p-value
0.000*
0.000*
0.001*
0.052***
0.202
0.263
0.324
0.255
Source: Author's calculation
Note: *denotes rejection of the null hypothesis of no
cointegration at 1% significance level, ***denotes
rejection at 10% significance level
The following restrictions were imposed:
•β tb =1
•α rer_aut= α gdp_ita = α gdp_aut = αgdp_cro=0
•β gdp_cro = -1;
•α rer_aut = α rer_de
•β gdp_aut =- β gdp_de
Above mentioned restrictions were jointly
accepted by a LR test (  2 ( 7 )  8 . 8401 , p-value of
0.2670)
Econometric results and their implications
tbt = -153.60 + gdp_crot -2.88gdp_det + 2.88gdp_autt
+ 5.03 gdp_itat + 6.63rer_det+ 8.399 rer_autt -11.88
rer_itat
Unexpected gdp_de and gdp_cro sign:
Croatian exports structure uncorrespondance
to German imports demand
rer_de and rer_aut coefficients:
tb worsening as a long-run result of kuna
depreciation (exports is often generated by imports
in Croatia, e.g. shipbuilding)
VEC model
variable
Δtb t-1
Δtb t-2
Δtb t-3
Δtb t-4
Δgdp_cro t-1
Δgdp_cro t-2
Δgdp_cro t-3
Δgdp_cro t-4
Δgdp_de t-1
Δgdp_de t-2
Δgdp_de t-3
Δgdp_de t-4
Δgdp_ita t-1
Δgdp_ita t-2
Δgdp_ita t-3
Δgdp_ita t-4
Δgdp_aut t-1
coefficient
0.460790
-0.230929
0.150000
-0.684785
4.11479
-3.56807
-1.56398
-2.80733
-7.13117
-1.15130
5.85703
0.0664882
-3.30309
9.45495
-8.92433
1.72359
-2.99187
t-value
0.898
-0.468
0.346
-1.62
2.35
-1.51
-1.03
-2.22
-1.18
-0.189
0.918
0.0113
-0.659
1.80
-1.33
0.413
-1.22
variable
Δgdp_aut t-2
Δgdp_aut t-3
Δgdp_aut t-4
Δrer_de t-1
Δrer_de t-2
Δrer_de t-3
Δrer_de t-4
Δrer_ita t-1
Δrer_ita t-2
Δrer_ita t-3
Δrer_ita t-4
Δrer_aut t-1
Δrer_aut t-2
Δrer_aut t-3
Δrer_aut t-4
constant
ECT t-1
coefficient
5.41158
1.17847
5.40780
-12.9903
5.78325
4.88599
3.04197
10.4275
0.461034
-2.63489
-4.88785
0.397508
-7.80636
-0.628294
0.623153
106.568
-0.347350
t-value
1.89
0.409
1.83
-0.976
0.452
0.411
0.204
1.84
0.121
0.891
-1.75
0.0324
-0.666
-0.0569
0.0468
1.78
-1.78
Properties of VECM residuals
test
test statistics
AR 1-1
F(1,5) =
test
2.7624
ARCH 1-1
F(1,4)
test
=0.0036441
Normality
χ2(2) =
test
5.3125
RESET test
F(1,5) =
0.54866
p-value
0.1574
0.9548
0.0702
0.4922
Croatia vs. Germany
Results of Johansen's cointegration
test for CRO vs. DE model
rank eigenvalu
e
0
0.48061
1
0.40020
2
0.048563
3
0.72814
trace
p-value
54.234
25.410
2.9185
0.72814
0.010*
0.152
0.963
0.393
Source: Author's calculation
Note: *denotes rejection of the null
hypothesis of no cointegration at 1%
significance level
tbt = -0.39gdp_crot + 2.27 gdp_det + 1.43rer_det
• GDP coefficients confirm economic theory
• rer_de elasticity coefficient suggests tb deterioration
in case of a devaluation
Uncompetitive economic structure
Import dependency of the Croatian
economy
Croatia vs. Italy
Results of Johansen's cointegration test
rank
0
1
2
3
eigenvalue
0.45911
0.19462
0.061125
7.099E-005
Source: Author's calculation
trace
39.342
12.302
2.7784
0.00312
p-value
0.250
0.917
0.969
0.955
Granger causality test results
Direction of causality
dgdp_cro → dtb
dtb → dgdp_cro
dgdp_ita → dtb
dtb → dgdp_ita
drer_ita → dtb
dtb → drer_ita
dgdp_ita → dgdp_cro
dgdp_cro → dgdp_ita
drer_ita → dgdp_cro
dgdp_cro → drer_ita
drer_ita → dgdp_ita
dgdp_ita → drer_ita
F-statistic
0.31761
0.20864
0.00535
0.51184
1.73082
0.93491
0.17043
2.57628
0.42935
3.63060
0.43403
2.04470
Probability
0.72985
0.81263
0.99467
0.60357
0.19117
0.40170
0.84396
0.08964
0.65413
0.03633
0.65115
0.14379
Relationship direction opposed to the expected?
Croatia vs. Austria
Results of Johansen's cointegration
test for CRO vs. AUT model
rank eigenvalue trace
0
0.47123 48.181
1
0.31109 20.143
2
0.073882 3.7473
3 0.0083767 0.37013
p-value
0.045*
0.424
0.916
0.543
Source: Author's calculation
Note: *denotes rejection of the null hypothesis of no
cointegration at 1% significance level,
tbt = -0.82gdp_crot + 1.91gdp_autt + 0.71 rer_autt
 Confirmation of the CRO vs. DE model
conclusions
 rer_aut coefficient opposed to economic theory
Concluding remarks
 Marshall-Lerner condition & J-curve nonvalidity in
Croatia?
 Real economic problems should primarily be solved
by real variables and measures?
 Possible shortcomings:
oshort time span
othe need of including other trade partners in
the analysis
 Kuna devaluation effects should be observed much
wider