Institutions and Economies

Vol. 9, No. 4, October 2017, pp. 71-87

Effects of Palm Oil Price on Exchange

Rate: A Case Study of Malaysia and
Indonesia
Mukhriz Izraf Azman Aziza, Shri-Dewi Applanaidub

Abstract: This paper investigates the impact of palm oil prices on exchange rates in
Malaysia and Indonesia using the Dynamic Ordinary Least Squares (DOLS) model. The
paper uses real monthly data from 1983:1 to 2015:5 and follows three estimation steps:
(i) determination of the integrational properties of the data, (ii) testing for cointegration
relationship through bounds testing method, and (iii) estimating the long run impact of
real palm oil price, real crude oil price and real interest rate differential on real
exchange rate. The finding indicates that real palm oil prices have significant negative
effects on real exchange rate. While coefficient estimates differ for Malaysia and
Indonesia, however, they tend to be around 0.2. In other words, a 10% increase in the
real price of palm oil leads to appreciation of about 2% in the equilibrium exchange
rate in Malaysia and Indonesia. The findings confirm that an increase in palm oil price
leads to exchange rate appreciation.

Keywords: palm oil price, exchange rate, Malaysia, Indonesia.

JEL Classification: Q17, Q43

Article Received: 15 February 2017; Article Accepted: 20 May 2017.

1. Introduction

The link between exchange rate and crude oil prices has been a subejct of
interest among many scholars . Thus, Golub (1983) and Krugman (1983, a.
b) were among the earliest scholars to note the significant role of crude oil
prices in explaining exchange rate movements. They argued that an
increase in crude oil prices generates a corresponding surplus for oil
exporters and deficits for oil importers thereby causing reallocation of
wealth, which eventually impacts on exchange rates. This has repercussions
for both oil-exporting and importing countries due to appreciation or
depreciation in exchange rate in case crude oil prices go up, and vice-versa
when crude oil prices fall. For oil exporting countries such as Malaysia and

a Department of Economics and Agribusiness, School of Economics, Finance and Banking,

Universiti Utara Malaysia. Email: mukhriz@uum.edu.my
b Department of Economics and Agribusiness, School of Economics, Finance and Banking,
Universiti Utara Malaysia. Email: dewi@uum.edu.my
72 Mukhriz Izraf Azman Aziz, Shri-Dewi Applanaidu

Indonesia where oil exports contribute significantly to their economies,

studies have generally found a negative relationship between crude oil price
and exchange rates, i.e. an increase in oil prices leads to an appreciation of
the domestic currency (see Zalduendo, 2006; Korhonen & Juurikkala,
2009; Aziz, Dahalan & Hakim, 2013). There are insufficent studies on
crude palm oil price’s effect on exchange rate. While recent studies by
Ashfahany and Priyatna (2015) and Kiatmanaroch and Sriboonchitta (2014)
showed that palm oil price significantly affects the Rupiah and Ringgit, the
authors did not provide theoretical justification linking these two variables.
Moreover, simplicity in the modelling framework of both studies suggests
that the results could suffer from omitted variable bias.
This paper therefore aims to investigate the impact of palm oil prices on
exchange rate in Malaysia and Indonesia from 1983 to 2015. The paper
contributes to the literature in three ways. First, it complements the
methodologies employed in Ashfahany and Priyatna (2015) and
Kiatmanaroch and Sriboonchitta (2014) on the use of Dynamic Ordinary
Least Squares (DOLS) with structural breaks. The estimates produced by
DOLS with structural breaks are robust despite the endogeneity issues
among its regressors. Second, in addition to palm oil prices, in controlling
the omitted variable biasness, two important determinants of exchange rate
movements, namely real crude oil price and real interest rate differential,
are incoporated into the modelling framework. The inclusion of the real
interest rate differential is motivated by uncovered real interest rate parity
as exhibited by Meese and Rogoff (1988), while the inclusion of real crude
oil price follows the work of Chen and Chen (2007). Third, in describing
the theoretical link between real exchange rate and real palm oil price, the
paper applies Amano and van Norden (1998) terms of trade model that
describes the mechanism through which changes in real palm oil price
could affect the real exchange rate.
The paper is further organised as follows. Section 2 discusses, briefly,
the importance of the palm oil industry in Malaysia and Indonesia while
section 3 presents theoretical justification and methodology of the paper.
Section 4 discusses results of the unit root and cointegration tests, while
Section 5 examines the long run effect of palm oil price on exchange rate.
Section 6 concludes the paper.

2. Brief Review of Palm Oil and Oil and Gas Industries in Malaysia
and Indonesia

The four commonly traded edible oils in the agricultural commodity market
(namely palm oil, soybean, sunflower and rapeseed), soybean oil and palm
oil account for roughly 55 percent of the total world production in 2014. It
 Effects of Palm Oil Price on Exchange Rate 73

should again be brought to attention that palm oil currently is the most
consumed edible oil in the world, with Malaysia and Indonesia being the
top two producers, contributing 85% of the world’s export and around 5
percent of Gross Domestic Product (GDP) respectively. It is popular
because of the lower cost and high oxidative stability of the refined product
when used for frying. Additionally, palm oil is often blended with other
fuels to create palm oil biodiesel blends. These applications drive its
demand in the market, thus competing with soybean for a share in edible oil
and biodiesel markets.
Crude palm oil (CPO) is considered as one of the most important
contributors to Malaysia’s economy. It is the fourth largest contributor to
gross national income (GNI), accounting for RM52.7 billion or 8% of GNI
in 2011 and it is expected to increase to RM178 billion by 2020 (Abdullah,
Dahlan & Rahman, 2015). Acccording to the Malaysian Palm Oil Council
(MPOC), Malaysia currently accounts for 39% of world palm oil
production and 44% of world exports. Taking into account other oils & fats
produced in the country, Malaysia accounts for 12% and 27% of the
world's total production and exports of oils and fats respectively. The
significance of palm oil industry is well noted when it was identified as
one of the 12 National Key Economic Areas (NKEA) to drive the nation’s
economy. The major aim of this sector, according to the NKEA, is to
improve upstream productivity as well as increase downstream expansion,
while focusing on the sustainable development of the oil palm industry.
Besides palm oil, the oil and gas (O&G) industry plays an important
role in the Malaysian economy by contributing one-tenth of the national
GDP over the past decade. Malaysia is an important world energy market
because of its large oil and natural gas resources. It is the second-largest
O&G producer in the Association of Southeast Asian Nations (ASEAN),
where the excess of O&G produce are exported to neighbouring countries
such as Singapore, South Korea, Thailand and Japan. Petroleum exports in
2014 contributed significantly to the revenue of the Malaysian
government. Revenue from the O&G sector accounted for around 30% of
the government revenue, averaging around RM66 billion in 2014
(Pemandu, 2014). The revenue is in the form of petroleum income taxes,
oil and gas royalties and dividends paid by Petronas 1 and other
international players such as Shell and Exxonmobil. This revenue has
assisted the government in undertaking development by spending on
infrastructure, education and healthcare, thus contributing further to the
country’s long-term productive capacity.
The Malaysia Palm Oil Board (MPOB) reported that Indonesia overtook
Malaysia as the biggest palm oil exporter in 2008 and currently its global
market share is over 50%. It is a major contributor to Indonesia’s GDP at
around 4.5%. Private enterprises produce 48% , small holder farmers 40%,
74 Mukhriz Izraf Azman Aziz, Shri-Dewi Applanaidu

and state owned plantations, 12%. About 70% of oil palm plantation is
located in Sumatra, which is the main production hub while other
plantations are located in East and West Kalimantan. It is important to note
that exports have been growing with an average of over 70% of total
production targeting international markets, India and China being the main
destinations, followed by the Netherlands and Singapore. In Indonesia,
energy is not just an important economic contributor, but also a principal
contributor to the country’s export earnings, GDP and government
revenues. The significant contribution of energy to Indonesia’s economy
was clear during the oil boom period (from late 1970s to early 1980s).
Data shows that for the last decade, the share of energy sector (O&G and
mining) to Indonesia’s GDP was continuously declining, from about 15
percent in 2000 to about 10 percent currently, due particularly to rapid
growth of the manufacturing and services sectors (Jakarta Post, 2010).

3. Theoretical Justification and Methodology

3.1 Theoretical justification

A number of studies have examined the relationship between commodity

prices and the real exchange rate (see Amano & van Norden, 1998; Cashin,
Céspedes & Sahay, 2004; Chen & Rogoff, 2002; Douglas, Thompson &
Downes, 1997; Edwards, 1985a; Edwards, 1985b). Most of these studies
showed a significant relationship for both developing and developed
countries and more so for the former whose exports tend to be dominated
by commodities (Ngandu, 2005). According to Cashin et al. (2004),
commodity prices are likely to be the most important source of persistent
change in the real exchange rate of commodity-dependent countries, most
of which are developing countries. They pointed out that although terms of
trade fluctuations are significant in explaning real exchange rates
movements, there has been no comprehensive work done to explain how
changes in real commodity prices affect the real exchange rate. Therefore,
the current paper will assess the potential impacts of real palm oil price on
the real exchange rate using the trade model developed by Amano and van
Norden (1998).

3.2 Model Specification

Meese and Rogoff (1988) examined the link between real exchange rates
and real interest rate differentials. The real exchange rate, qt (in log), can be
expressed as:
 Effects of Palm Oil Price on Exchange Rate 75

qt ≡ et – pt + pt* (1)

where et is logarithm of nominal exchange rate (domestic currency per

foreign currency unit) and pt and pt* are the logarithms of domestic and
foreign prices. Here, three assumptions are made: first, that when a shock
occurs, the real exchange rate returns to its equilibrium value at a constant
rate; second, that the long-run real exchange rate, , is a non-stationary
variable; finally, uncovered real interest rate parity (UIP) is fulfilled:

Et (qt+k – qt) = Rt – Rt* (2)

where Rt* and Rt are respectively the real foreign and domestic interest rates
for an asset of maturity k. Combining the three assumptions above, the real
exchange rate can be expressed in the following :

qt = -δ(Rt – Rt*) + t (3)

where δ is a positive parameter larger than unity. Equation (3) leaves

relatively open the question of which are the determinants of t that are
non-stationary variables. The next section discuses the possible
incorporation of real palm oil price on real exchange rate movemnents.

3.2.1 Incorporating palm oil price

Amano and van Norden (1998) explained that the model linking terms of
trade and exchange rate movemnents may be utilised to clarify the link
between palm oil prices and exchange rates. Consider a small country with
two sectors of tradable and non-tradable goods, whereby each sector
exploits both a tradable input (palm oil) and a non-tradable input (labour),
in addition to constant-returns-to-scale technology, with an assumption
that the inputs are mobile between sectors and that none of the sectors
make profits. The output price of the tradable sector is fixed
internationally; hence, the real exchange rate corresponds with the output
price in the non-tradable sector. In this case, a rise in the palm oil price
will lead to a decrease in the labour price in order to satisfy the
competitiveness requirement of the tradable sector. On the other hand, in
case the non-tradable sector uses more tradable input than the tradable one,
its output price will rise leading to the real apprciation of the exchange
rate. The opposite will occur if the non-tradable sector employs less
tradable input than tradable one. This has an implication for a palm oil-
exporting country such as Malaysia and Indonesia, where a real palm oil
price increase may result in the appreciation of the real exchange rate as
76 Mukhriz Izraf Azman Aziz, Shri-Dewi Applanaidu

prices of non-tradable goods increase relative to tradables and vice-versa.

Correspondingly, this study describes the real exchange rate (RER) as a
function of the real price of oil (ROIL), real palm oil price (RPALM) and
real interest rate differential (RDR). That is,

RER = F(ROIL, RPALM, RDR) (4)

One may argue against expression (4) by asserting that it neglects the
fact that some other important variables may be missing. However, it is
crucial to note that this study aims at exploring the long-term relationship
between the real exchange rate and the relevant explanatory variables,
especially real palm oil price and its contribution to fluctuations of the real
exchange rate. If the study finds a cointegrating relationship among the
variables in the model, this will imply that there is no serious problem in so
far as missing important variables are concerned, or omitted variable bias.
A similar approach in modelling exchange rate as a function of commodity
prices can also be found in the work of Chen and Chen (2007) and
Korhonen & Juurikkala (2009).

3.3 Data and the long run econometric estimation

This study makes use of monthly data of oil price, palm oil price, nominal
exchange rate and interest rate for Malaysia and Indonesia from January
1983 to May 2015 sourced from the International Financial Statistics (IFS).
Real exchange rates (RER) are derived from domestic price level and price
level in a foreign country. Real exchange rate is the product of nominal
exchange rate and the ratio of foreign to domestic price. Real crude oil
price (ROIL) is defined as the price of monthly average crude oil expressed
in US dollars, deflated by domestic consumer price index (CPI). Real palm
oil price (RPALM) is defined as the price of monthly palm oil expressed in
US dollars, deflated by domestic CPI. Real interest rate differentials (RDR)
is calculated as RDRit= rt – rt*, where rit is the real interest rate of
domestic country and rt* is the real foreign interest rate. Real interest rate is
derived using the Fisher equation. The real interest rate solved from the
Fisher equation is (1 + Interest) / (1+Inflation) -1. The Hodrick Prescott
filter is applied to RDR monthly series to smooth out noisy fluctuations in
the series. The United States (US) is chosen as the numeraire country.
Logarithmic transformations of RER, ROIL and RPALM are taken before
the analysis. The RDR is not in log form as the series contain negative
integers.
 Effects of Palm Oil Price on Exchange Rate 77

The long run model to be estimated is given as:

ln( RER ) t   1   1 ln( ROIL ) t   2 ln( RPALM ) t   3 ( RDR ) t   t (5)

In this situation, all explanatory variables are expected to have negative

coefficient signs. Specifically, an increase in the real interest rate
differential (RDR) will lead to the appreciation of the currency. Hence, for
oil exporting countries like Malaysia and Indonesia, an increase in the real
price of crude oil (ROIL) is expected to lead to an appreciation of the real
exchange rate. Likewise, an increase in palm oil price would lead to
exchange rate appreciation.

4. Unit Root Test and Cointegration

Before one estimates the long run impact of palm oil on exchange rate, it is
important to identify the properties of the data as well as the existence of
long run relationships between the variables. This section discusses the
results of the unit root and cointegration tests.

4.1 Conventional unit root tests

It is essential to analyse the stationary properties of the data before

estimating the long run cointegrating regression. To achieve this, the
conventional Augmented Dickey-Fuller (ADF), Kwiatkowski–Phillips–
Schmidt–Shin (KPSS) and Phillips-Perron (PP) unit root tests are applied to
ROIL, RPALM, RER and RDR. Tables 1 and 2 present the results for
Malaysia and Indonesia respectively. Of the four variables, RER and ROIL
are integrated at order one or I(1) at 1% significance level when using all
three tests for both countries. However, the plot of the log of the series
suggests that RER and ROIL might be stationary with a structural break or
more than one break (Figure 1 and 2). This is not surprising because crude
oil prices and exchange rates may have been affected by major events.
Failing to account for structural changes may bias the conventional tests for
stationarity that lead to the non-rejection of a unit root, as pointed out by
Perron (1989).
78 Mukhriz Izraf Azman Aziz, Shri-Dewi Applanaidu

Table 1: Conventional Unit Root Tests-Malaysia

Crude Oil Interest Rate
Variable Palm Oil Price Exchange Rate
Price Differential
Series in level
ADFa -3.367564** -1.92904 -2.574080 -3.934835***
KPSSb 0.242767 0.344852*** 0.485727*** 0.528550**
PPa -2.843748* -2.057042 -2.826546 -4.080003***
Series in first difference
ADFa -7.746642*** -18.82635*** -9.687518*** -7.292135***
KPSSb 0.033991 0.050469 0.055378 0.053299
PPa -13.94678*** -18.84296*** -13.64799*** -17.85031***
Notes: a signifies that the null hypothesis is the unit root. b Signifies that the null
hypothesis of no unit root. * (**) *** denote statistical significance at the 10%, 5% and
1% levels.

Table 2: Conventional Unit Root Tests –Indonesia

Interest Rate
Variable Palm Oil Price Exchange Rate Crude Oil Price
Differential
Series in level
ADFa -2.8543 -2.1961 -2.9807 -5.2203***
KPSSb 0.2298*** 0.408725*** 0.4785*** 0.0752
PPa -2.4736 -3.0284 -2.3285 -4.3874***
Series in first difference
ADFa -7.8550*** -6.2054*** -6.5417*** -7.8178***
KPSSb 0.0416 0.0339 0.0405 0.0127
PPa -13.995*** -18.65369*** -13.515*** -10.292***
Notes: a Signifies that the null hypothesis is the unit root. b Signifies that the null
hypothesis of no unit root. *(**) *** denote statistical significance at the 10%, 5% and
1% levels.

On the contrary, RDR is integrated of order zero at 1% level when using

ADF and PP tests for both countries. For RDR, the series is stationary at
level because of the construction of the variables itself. Real interest rate
differential is derived from taking the difference (or the change) between
domestic and US real interest rate. Likewise, RPALM is an I(0) variable at
5% significance level under ADF and KPSS tests for Malaysia but it is an
I(1) variable for Indonesia when using all unit root tests. It is interesting to
note that careful observation from line plots of Figures 1 and 2 reveal
similar pattern of real palm oil price movements for Malaysia and
Indonesia, regardless of their contrasting results. This can be attributed to
palm oil prices, which are historically influenced by frequent uncertain
weather variations that negatively affect crop productivity and supply. A
case in point is the last three El-Niño seasons, which caused a sharp
slowdown in production; the worst being in 1998, with 7 percent reduction
annually. However, these frequent large fluctuations in RPALM may not
 Effects of Palm Oil Price on Exchange Rate 79

necessarily lead to structural breaks compared with the price trends in RER
and ROIL.

Figure 1: Malaysia
RER ROIL
1.6 5.0

1.4 4.5

1.2 4.0

1.0 3.5

0.8 3.0

0.6 2.5
1985 1990 1995 2000 2005 2010 2015 1985 1990 1995 2000 2005 2010 2015

RPALM RDR
7.5 .04

7.0 .02

6.5 .00

6.0 -.02

5.5 -.04

5.0 -.06
1985 1990 1995 2000 2005 2010 2015 1985 1990 1995 2000 2005 2010 2015

Figure 2: Indonesia
RER ROIL
10.5 6.5

6.0
10.0
5.5
9.5 5.0

9.0 4.5

4.0
8.5
3.5

8.0 3.0
1985 1990 1995 2000 2005 2010 2015 1985 1990 1995 2000 2005 2010 2015

RPALM RDR
10 .3

.2
9

.1
8
.0
7
-.1

6
-.2

5 -.3
1985 1990 1995 2000 2005 2010 2015 1985 1990 1995 2000 2005 2010 2015
80 Mukhriz Izraf Azman Aziz, Shri-Dewi Applanaidu

4.2 Unit root tests with structural break

In order to take into account the possible structural break in RER and ROIL
series, the study employed the unit root test by Zivot and Andrews (1992)
(ZA hereafter) and Perron (1997) (Perron hereafter) that allow for structural
breaks. This is because these two tests assume the null hypothesis of unit
root against the alternative of a trend stationarity process with a structural
break. It is significant to note that, in spite of considering structural breaks,
the study cannot reject the null hypothesis of a unit root in the ROIL and
RER series for both countries. Both ROIL and RER series are integrated of
order one I(1) at 5% significance level (see Tables 3 and 4).
Interestingly, the break detected by the tests for real crude oil price in
Malaysia roughly corresponds with the timing of the 1999 oil price collapse
which resulted from worldwide reduction in consumption due to Asian
economic decline and an uncertain warm weather in the US. For real
exchange rate, the structural change took place in the mid-1997 for
Malaysia and Indonesia, when Asian countries were overwhelmed with the
currency crisis. The results from Table 1 to Table 4 show that there is a
mixture of I(1) and I(0) of underlying regressors. It also indicates that RER
and ROIL series are integrated of order one regardless of the unit root tests
employed. Based on these results, the study proceeds to test whether these
variables are cointegrated using Pesaran et al. (2001) bounds cointegration
method. This method allows for testing the existence of long run
relationships between variables regardless whether they are integrated at
order one or zero. Their technique also avoids the problems of uncertainty
posed by the lack of power of unit root tests.

Table 3: Unit root with structural break tests-Malaysia

ZA test ZA break point PP test PP break point
Series in level
RER -4.88(0) 1997m07 -4.886(0) 1997m06
ROIL -4.5970(1) 1999m03 -4.6848(1) 1999m02
Series in difference
RER -19.234(0)** 1998m02 -21.291(0)** 1998m01
ROIL -14.3760(0)** 1999m01 -10.336(3)** 2008m12
Notes: The numbers in parentheses are the lag order. Two asterisks respectively denote
rejection of the null hypothesis of the presence of unit root at 5% level.
 Effects of Palm Oil Price on Exchange Rate 81

Table 4: Unit root with structural break tests-Indonesia

ZA test ZA break point PP test PP break point
Series in level
RER -3.805(3) 1997m07 -3.81(3) 1997m06
ROIL -4.93(1) * 1997m11 -4.96(1) 1997m10
Series in difference
RER -8.93(4) ** 1998m07 -12.88(4) ** 1998m01
ROIL -14.04(0) ** 1999m01 -96.9(3) ** 2008m12
Notes: The numbers in parentheses are the lag order. One/two asterisks denote rejection
of the null hypothesis of the presence of unit root at 10% and 5% level respectively.

4.3 Bounds cointegration test

The Pesaran et al. (2001) autoregressive distributed lag (ARDL)

cointegration test determines two sets of critical values for a given
significance level. The first critical values are calculated on the assumption
that all variables included in the ARDL model are I(1) series, while the
second one is calculated on the assumption that the variables are I(0) series.
Under the null hypothesis of no cointegration, the joint F-statistic is
rejected when the test statistic exceeds the upper critical bounds value,
while Ho is accepted if the F-statistic is lower than the lower bounds value.
If the F-test lies between the bounds, the cointegration test is inconclusive.
In the presence of cointegration (i.e. Ho is rejected), the study proceeds
with estimation of the long-run model of equation (5).

Table 5: F-statistic of Cointegration Relationship-Malaysia

Significance Bound Critical values*
Test statistic Value
level (restricted intercept and trend)
F-statistic 5.294 I(0) I(1)
1% 5.17 6.36
5% 4.01 5.07**
10% 3.47 4.45
Note: Two asterisks denote rejection of the null hypothesis of the presence of no
cointegration 5% level.

Table 6: F-statistic of Cointegration Relationship-Indonesia

Significance Bound Critical values*
Test statistic Value
level (restricted intercept and trend)
F-statistic 15.066 I(0) I(1)
1% 5.17 6.36***
5% 4.01 5.07
10% 3.47 4.45
Note: Three asterisks denote rejection of the null hypothesis of the presence of no
cointegration at 1% level.
82 Mukhriz Izraf Azman Aziz, Shri-Dewi Applanaidu

The bounds testing for Malaysia and Indonesia are estimated together with
structural break dummies of crude oil price and exchange rate variables.
Results of the calculated F-statistics for the cointegration tests are
displayed in Tables 5 and 6. For Malaysia, the calculated F-statistic (F-
statistic = 5.294) is higher than the upper bound critical value at 5 per cent
level of significance (5.07). For Indonesia, the F-statistic is equal to 15.066
and is statistically significant at 1 per cent. The results imply that the null
hypothesis of no cointegration cannot be accepted and that there exist
cointegration relationships between the exchange rates of Malaysia and
Indonesia and their determinants respectively.

5. Findings – Long Run Impact

This study found that if a cointegration relationship existed, equation (5) is

estimated using the DOLS as advocated by Saikkonen (1991) and Stock
and Watson (1993). The DOLS involves regressing one of the I(1)
variables on other I(1) variables, the I(0) variables, and lags and leads of
the first difference of the I (1) variables (Narayan and Narayan, 2004). The
estimates produced by DOLS are robust despite the endogeneity issues
among its regressors. It should be noted that when the unit root test with
structural break is performed, RER and ROIL are still I(1) variables,
indicating the presence of structural breaks have no significant impacts on
the series. Therefore, the study continues with estimating the long-run
elasticities of the impact of real oil price, real palm oil and real interest rate
differential on real exchange rate without structural break dummies. For
checking robustness, the study will estimate the long run regression with
structural break dummies. The two dummy variables enter as deterministic
terms to capture the structural breaks in the RER and ROIL series as
detected in the ZA and the Perron tests.
Tables 7 and 8 show results of the long run model estimated through the
DOLS. Amazingly, the two models in either case without or with dummy
variables provide similar results for Malaysia and Indonesia, thus
confirming the robustness of the long run model. ROIL and RPALM
parameters are statistically significant and have the expected negative
signs. Notably, between the two export commodities, palm oil price
(RPALM) was found to have a greater impact on exchange rate than crude
oil price in Malaysia. It is noted that estimations without deterministic
regressors, other things being equal, a 10 percent increase in palm oil price
(RPALM) appreciates the Ringgit by 2 percent. On the contrary, estimates
without deterministic regressors, with a 10 percent increase in crude oil
price (ROIL) showed an appreciation of the Ringgit by 0.74 percent only.
However, in the case of Indonesia, the impact of palm oil price on
 Effects of Palm Oil Price on Exchange Rate 83

exchange rate is noticed to be marginally greater than crude oil price when
estimated with deterministic regressors. It is found that a 10 percent
increase in palm oil price and crude oil price individually appreciates the
Rupiah by 2.9 percent and 2.2 percent respectively. Finally, the RDR
variable is negatively significant for Malaysia in both models but it is only
statistically significant for Indonesia when estimated without deterministic
regressors.

Table 7: Dynamic OLS –Malaysia

without deterministic regressors with deterministic regressors
Regressors
Coefficient t-statistics Coefficient t-statistics
β1ln(ROIL) -0.074*** -4.947 -0.025 -1.698*
β2ln(RPALM) -0.200*** -13.884 -0.240 -19.202**
β3(RDR) -2.491*** -9.112 -2.151 -7.567***
Dummy RER NA NA 0.182 4.484***
Dummy ROIL NA NA 0.048 3.122***
Notes: The DOLS was estimated by including up to two lags and leads. The results
presented here do not include lags and leads. * (**) *** denote statistical significance at
the 10%, 5% and 1% level

Table 8: Dynamic OLS –Indonesia

without deterministic regressors with deterministic regressors
Regressors
Coefficient t-statistics Coefficient t-statistics
β1ln(ROIL) -0.388*** -14.899 -0.223 -13.132***
β2ln(RPALM) -0.176*** -7.021 -0.285 -15.460***
β3(RDR) -0.258** -2.153 -0.060 -0.494
Dummy RER NA NA 0.166 2.406**
Dummy ROIL NA NA 0.272 5.393***
Notes: The DOLS was estimated by including up to two lags and leads. The results
presented here do not include lags and leads. * (**) *** denote statistical significance at
the 10%, 5% and 1% level.

Generally, findings from these estimates suggest that real crude oil
price and real palm oil price have negative effects on real exchange rate,
whereby higher prices result in real exchange rate appreciation.
Interestingly, previous literature established the fact that that real
commodity prices influence real exchange rates in commodity-exporting
countries. Those studies coincide with these findings for Malaysia and
Indonesia. Between RPALM and ROIL, the influence of palm oil price on
exchange rate is consistently higher than crude oil price in Malaysia. This
is somewhat perplexing given the relatively bigger contribution of the
O&G industry to the Malaysian economy compared with the palm oil
industry. One plausible explanation is that Malaysia is advantaged in the
palm oil industry as ‘price maker’ but is a ‘price taker’ in the O&G sector.
Consequently, the ability to influence the market price for palm oil exports
is reflected on the higher coefficient values of RPALM for Malaysia. The
84 Mukhriz Izraf Azman Aziz, Shri-Dewi Applanaidu

same situation is also true for Indonesia. In spite of the fact that the
contribution of O&G industry to Indonesia’s GDP is twice than that of
palm oil industry, the impact of palm oil price on the Rupiah outweighs the
impact of crude oil price. This is true when the long run model is measured
with the deterministic regressors.

6. Conclusion

The impacts of crude oil price, crude palm oil price and real interest rate
differential on Malaysian Ringgit and Indonesian Rupiah are examined
using monthly time series data from 1983:1 to 2015:5. This study uses the
Pesaran, Shin and Smith (2001) bounds testing method in determining
whether exchange rates are cointegrated with crude oil price, crude palm oil
price and real interest rate differential. In order to find out the existence of a
long-run relationship, the study utilises the DOLS method to determine the
long-run estimates. The empirical results substantiate that real palm oil
price and real crude oil price have statistically significant negative effects
on Malaysian and Indonesian exchange rates, whereby higher prices will
lead to an appreciation in real exchange rate. Given the dearth of studies
devoted to the analysis of the nexus between agricultural commodity prices
(palm oil price in particular) and exchange rate among commodity
exporting countries, findings from this study provide additional evidence
linking these two variables, and perhaps justifying the predictive ability of
palm oil price in explaining exchange rate movements of the Ringgit and
Rupiah.

Notes
1.
Petronas (or Petroliam Nasional Berhad) is Malaysia’s nationally owned
petroleum company.

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