Empirical Evidence On The Correlation Between The Exchange Rate And Romanian Exports

Abstract

Few subjects of international economics are so much exposed to heated debates as the exchange rate problem. From monetary crises and balance-of-payments adjustments to monetary zones, dealing with currency swings seems to embody any economist's worries about the rightfulness of economic models and the relevance of empirical analyses he or she has to choose. Is appreciation or depreciation good for a country's welfare? Would that answer still be valid in the long run? The unsettled character of the problem largely resides in the manifest contradiction between the firm theoretical predictions and their unconvincing empirical testing. One of the least uncontroversial tenets refers to the positive correlation between currency depreciation or devaluation (although of different origins, their effects are generally the same) and a country's current account. This paper attempts to test this prediction on the case of Romanian economy and to conclude on possible explanations of the theoretical-empirical conflict.

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EMPIRICAL EVIDENCE ON THE CORRELATION
BETWEEN THE EXCHANGE RATE AND ROMANIAN EXPORTS

Valentin COJANU (cojanu@ase.ro)
Academy of Economic Studies Bucharest
Cristian PĂUN (cpaun@ase.ro)
Academy of Economic Studies Bucharest
Radu LUPU (ralupu@gmail.com)
Academy of Economic Studies Bucharest

INTRODUCTION
Few subjects of international economics are so much exposed to heated debates as the
exchange rate problem. From monetary crises and balance-of-payments adjustments to
monetary zones, dealing with currency swings seems to embody any economist's worries
about the rightfulness of economic models and the relevance of empirical analyses he or she
has to choose. Is appreciation or depreciation good for a country's welfare? Would that
answer still be valid in the long run?

The unsettled character of the problem largely resides in the manifest contradiction between
the firm theoretical predictions and their unconvincing empirical testing. One of the least
uncontroversial tenets refers to the positive correlation between currency depreciation or
devaluation (although of different origins, their effects are generally the same) and a
country's current account. This paper attempts to test this prediction on the case of Romanian
economy and to conclude on possible explanations of the theoretical-empirical conflict.

The choice of the present topic is timely for reasons of both practical significance and
research considerations. The beginning of 2005 confronted Romanian exporters with a double
shock of the termination of tax incentives they enjoyed on export profits and the sharp
national currency appreciation in real and nominal terms. The economic predictions were
claimed to hold true and, because the tax implementation had been long before
communicated, an ill-maneuvered exchange rate policy control on behalf of the National
Bank of Romania (NBR) was seen at the root of most of the industries' adjustment difficulties
that made trade deficits ever larger from year to year. While it is beyond the scope of this
paper to argue on the role the NBR played in the process, it however is of great importance to
see if the currency fluctuations indeed exerted a certain influence on the dynamics of exports
growth over long intervals. This research thus includes in statistical tests monthly variations
of exchange rates and trade volumes over a four-year period (January 2002 - December 2005)
in order to seek for most recent supporting evidence of the exporters' claims.

As for its research relevance, this theme follows up previous efforts to emphasize the
empirical nature of the correspondence in the context of the Romanian economy. The
following section presents the results of such endeavors, which by and large cover the whole
period from 1991 to 2000, and contrasts their findings against the standard macroeconomics
expectations. This analysis also takes on the task of enlarging the informational content of the
referred works by three additional methodological intakes: a data bank of forty-seven
observations, which reasonably exceeds most of the previous researches; a separate account
of the observed correspondence on one of the probably most affected industries; and a
parallel investigation of different regressions as the exchange rate is assumed to produce
deferred effects.

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LITERATURE REVIEW

The analytical framework does not make the study of the exchange rate and its impact on the
volume of trade an easily tractable issue. A long list of divergent explorations in the field, as
surveyed inter alia by Copeland (2005) and Salvatore (1990), witnesses the economists'
effort to deal with its complexity. The problems are grounded on an intricate web of circular
causations and multiple dependencies that normally characterize the real-world exchanges of
goods and currencies. As suggested by the proposed reference to the Romanian literature, this
paper conveniently groups the scholarship relative to the observed correspondence in three
largely distinct argumentative lines of research: the modeling methods of correcting balance-
of-payments disequilibria; the absorption capacity of the anticipated impact in the economy;
and the conditions of the open-economy environment.

The first concern raises the issue of accommodating the correlation into the appropriate
analytical framework. The usual treatment begins with the undisputable fact that a
depreciation or devaluation stimulates the nation's exports and discourages its imports, while
the contrary fluctuation has the opposite effect. The former alternative, which for the
expositive simplicity is to be given preference, makes the plausible assumption that
foreigners find the domestic goods more attractively priced and so help promote sales of
domestically produced goods. Increased foreign reserves and national production will soon
reverse the direction of the depreciating currency and thus automatically adjust the balance-
of-payments disequilibria, of which the current account (CA) balance is of paramount
importance for an economy heavily integrated in the world economy primarily by means of
its "visible" transactions only. That admittedly is the case of the Romanian economy. The
automatic correction however is dependent on at least three separate, but interdependent
influences, namely price, income, and monetary adjustment mechanisms.

Their simultaneous handling usually requires broad ceteris paribus conditions in order not to
make from the equilibrium condition an elusive possibility. One important insight however is
the supposition of automatic adjustment that turns economists toward a tangible theoretical
product: the equilibrium real exchange rate that is the rate for which there is neither a surplus
nor a deficit in the current account at its long-run level. The works of Lazea suitably expose
these technicalities on the Romanian case. His approach rests on a hypothetical economic
functioning (Lazea 1993) and makes recourse to a diagrammatic exposition to control for the
effect of the interest rate as a monetary instrument. On this basis, he concludes that a
balanced current account is better achieved through a policy-mix of managed exchange rate
and interest rate liberalization. In subsequent studies (Lazea 1994a, Lazea 1994b), he
attempted to regress the CA evolution dependent on the average monthly fluctuations of the
real exchange rate from August 1993 to February 1994.

His results – the exchange rate accounts for somewhat between 88% and 90% of the CA
evolution – would have been considered a substantive empirical evidence, had it not been for
two adjacent outcomes inferred from the same set of data. First, a correlation of
coincidentally similar magnitude, but in reverse dependence, also was statistically significant.
Second, an attempt to use the first correspondence for predictive purposes would have ended
up in "hazardous" conclusions. What remains though, Lazea argues, consists in finding an
estimate of the equilibrium exchange rate at the level which best explains the independent
variable. A recent research of Zaman (2000) generally follows the same analytical path, but
extends the number of observations to fifty-one and introduces additional dependent variables

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in two separate regressions on export and import dynamics. That study's conclusions
strengthen the view that exports are positively correlated, even if other factors such as the
value-added tax or inflation also exercise their impact in a similar direction.

As a general rule, the second step in assessing the theoretical predictions deals with the
circumstances under which the economy actually absorbs the presumed effect of the
competitive depreciation. The expected response arguably involves a time lag which may
vary from a minimum estimated to six months (Salvatore 1990; Krugman & Obstfeld 2003)
to over three years (Salvatore 1990) due to a host of circumstantial factors like the cumulative
effect of depreciation, trade elasticities or identification problems. The surprising findings of
the applications to the Romanian case (Lazea 1994a; Croitoru 1993; Daianu 1996) are that
the industries proved remarkably sensitive in promptly transferring currency devaluations in
export growth with apparently no time lag. However, a closer look at the documentary
evidence those referred authors provide unambiguously shows that their conclusion remains
valid under extreme circumstances, namely when the currency fluctuation is severe in the
short run. After a theoretically presumed threshold level with that observed characteristics is
passed by, one may notice that the correlations regain their somewhat hectic relationship.

Finally, a difficult problem in estimating a relevant correspondence rests on the particular
conditions of the macroeconomic environment. One widespread but often neglected
assumption requires open exchanges on both goods and currency markets. It should be also
added that considering alternatively different exchange rate policy regimes reveals perverse
effects on the expected correlation. To compound matters even more, the estimations which
used Romanian data were strictly qualified by serious deviations from the standard context.

Their results suffer from either data limitations due to incipient statistics or reduced
observations, or arbitrary policy manipulation, mainly in the form of administrative controls
on foreign exchange reserves. The problem of multiple dependencies was more often than not
visible. For example, Daianu (1996) notices how the relatively more favourable conditions of
borrowing in foreign currency strongly underpinned a sustained increase of imports in spite
of the depreciating domestic currency.

All these considerations suggest that any investigation on the correspondence between the
exchange rate and exports dynamics has to be seriously qualified by unforeseen or hardly
tractable circumstances which may simply make it irrelevant. It is for this reason that the
following examination attempts to keep to its essentials the logical correlation, while
providing a reasonably wide set of observations for increased statistical accuracy.

THE EVOLUTION OF ROMANIAN EXPORTS DURING 2002 – 2005

The exports play a fundamental role in sustainable development of a country. The volume
and dynamic of these exports reflect the structural changes in the economy, its performances
and the external competitiveness of a country of its international commercial and financial
transactions. The improvement of external competitiveness in terms of exports could be
sustained by a lot of policies and measures that take into consideration the stimulation and
promotion of local products on international markets.

In the year 2002 the exports FOB of Romania was 13868.8 millions US dollars, with 21.8%
(+2483,8 millions USD) higher than in the year 2001. By countries, comparatively with the
year 2001, the exports in developed countries have increased (+21,9%), and among these the

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exports with European Union were higher with 20.5%. The weight of developed countries in
total Romanian exports was 74.5% and for European Union 67.1%. In 2002, the first five
commercial export partners were Italia (25,0% from total exports), Germany (15,6%), France
(7,6%), United Kingdom (5,8%) and USA (4,3%). In that year the commercial deficit of the
balance of payments was -3987.9 millions USD (4166,6 millions USD in 2001) and
expressed in prices FOB/FOB, was -2613.3 millions USD in 2002.

The FOB exports realized in 2003 were 15613.7 millions Euros (17618.0 millions of USD),
this value being higher with 6.4% than 2002 (in USD this value is higher with 27.9%). By
countries, comparatively with 2002, the value of exports, expressed in euro, in developed
countries is increasing with 5.6% and for the exports in European Union had an increase rate
of 7.2%. The weight of these countries in total Romanian exports was 74% for developed
countries and 67.7% for European Union. The weight of exports to developing countries has
decreased with 0.7% and it was 14.5% from total exports in 2003. The exports in transition
countries have increased with 24.1% in that year. The first five export commercial partners in
2003 were: Italy (24,2% from total exports), Germany (15,7%), France (7,3%), United
Kingdom (6,7%) and Turkey (5,1%). The commercial FOB/CIF deficit in 2003 was -5587.6
millions USD (-6385 millions USD) and expressed in prices FOB/FOB this deficit was -
3955.5 millions Euros (4537.3 millions of USD).



In 2004 the FOB exports were 18934.7 millions Euros, this value being higher than in 2003
with 21.3%. The exports to European Union (UE-25) is increasing with 20.1%, having a total
weight from total exports of 72.9%. In 2004 the first five commercial partners were: Italy
(21,2% from total exports), Germany (15,0%), France (8,5%), Turkey(7,0%) and United
Kingdom (6,7%). The commercial FOB/CIF deficit in 2004 was -7346.3 millions Euros and
expressed in prices FOB/FOB this deficit was -5323.2 millions of Euros.

The exports realized in 2005 (less December) were 20433.3 millions Euros, this value being
higher with 17.4% than the same period from 2004. The value of exports with European
Union (UE – 25) in 2005 has increased with 9.4% comparatively with previous year. The
weight of these exports to European Union was 68.2% from total exports. The most important

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five commercial partners (with a weight of more than 40% from total exports) were: Italy
(19.4% from total exports), Germany (14.1%), Turkey (7.8%), France (7.5%) and United
Kingdom (5.6%). Taking into consideration the custom regime applied to these exports, in
2005 the definitive exports had a weight of 51.7% from total exports and the remaining
48.1% represents lohn contracts based on temporarily imports of raw materials. The
commercial FOB/CIF deficit in 2005 (less December) was -9006.7 millions Euros, and in
prices FOB/FOB the deficit was -6740.4 millions Euros. The manufacturing degree had
permanently improved according with the restructuring of Romanian economy and the
increasing of the importance of private sector in this economy.



The increasing of Romanian exports reflects a better capacity of the local economy to offer
qualitative products on external market, the improvement of managerial skills in export
activities, a higher interest for internationalization of business and a better access to external
market due to the commercial agreements. The most important growth rate, in the last period,
had the exports of manufactured goods such as: metallic manufactured goods (24,2%);
electric machineries and equipments (17,7%); transport equipments and ships (41,8%);
chemical products (38.3%); plastic materials (23.9%). The exports of raw materials and less
manufactured goods tend to decrease in the last period: aluminum, metal residuals, paper and
steel had the higher decreasing rate.

Taking into consideration this evolution, we can observe the following characteristics for
Romanian exports: 1). a positive evolution with an increasing of volume and manufacturing
degree; 2). an important concentration to a single area for exports – EU market; 3). a focusing
of exports mainly on developed countries; 4). a concentration in terms of structure of exports
on few main industrial sectors and 5). an important role played by lohn contracts in the
structure of these exports. Even the volume of exports is significantly increased in the last
years, the manufacturing degree is improving, there still are a lot of problems in terms of
competitiveness for Romanian exports that requires a lot of efforts from the government and
other institutions involved in export stimulation and promotion.

THE EVOLUTION OF EXCHANGE RATE AND INFLATION DURING 2002 – 2005

The monetary policy of the Central Bank has been significantly adjusted in the last period of
time, the price stability becoming the most important objective. Inflation targeting offers an
additional stability to the Romanian economy (so important for a durable economic growth)
by establishing a very precise further inflation rate. In this framework, the flexibility of
exchange rate represents a very important condition, in order to achieve the target of