The impact of international oil prices on the industrial production index in vietnam

Beside the impact of international oil prices, the paper also uses other variables such as real money supply, real exchange rate and structural break in order to find out the relationshi

VIETNAM – NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

THE IMPACT OF INTERNATIONAL OIL PRICES ON THE INDUSTRIAL PRODUCTION

INDEX IN VIETNAM

BY

NGUYEN THI HAU

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

HO CHI MINH CITY, NOVEMBER 2013

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UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES

HO CHI MINH CITY THE HAGUE

VIETNAM THE NETHERLANDS

VIETNAM – NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

THE IMPACT OF INTERNATIONAL OIL PRICES ON THE INDUSTRIAL PRODUCTION

INDEX IN VIETNAM

A thesis submitted in partial fulfillment of the requirements for the degree of

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

By

NGUYEN THI HAU

Academic Supervisor:

Dr CAO HAO THI

HO CHI MINH CITY, NOVEMBER 2013

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ACKNOWLEDGEMENT

This thesis could not completed without considerable and kindly mental supports from my supervisor, Dr Cao Hao Thi, who spend his valuable time to help me to find materials, books and super my schedule tightly He also responses quickly as soon as I ask for help and give comments, which partly contribute to the success of this thesis From bottom of my heart, I sincerely thank him for all

This study also benefits greatly from the enthusiastic assistance of Dr Truong Dang Thuy, whom I got knowledge on econometric and suggest the suitable models for the study

I would like to express my thanks for all students of MDE 16 for their unceasing assistance and encouragement and show deep gratitude to the lectures, VNP staffs, and library staffs for their helps in accumulating knowledge, accessing dataset and materials as well

Last but not least, it gives my deepest grateful to my family members, husband, manager and colleagues for their dear encouragement, give favorable times and opportunities to finish the M.A course as well as the thesis

I pledge to bear full responsibilities for errors, omissions and shortcomings of the study

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ABSTRACT

This thesis focus on analyzing the impact of oil prices on the industrial production index in Vietnam Beside the impact of international oil prices, the paper also uses other variables such as real money supply, real exchange rate and structural break in order to find out the relationship between these variables and industrial production index The data of those variables is monthly data, from January 1999 to December

2011 Regarding the methodology, the linear regression model and error correction model suggested to apply for balanced data set The test results show that oil prices fluctuation have positive impact on the economic activities throughout the industrial production index in the long run Based on that, the Vietnamese economy can adjust itself to adapt with the fluctuation of the international oil prices in the long run In contrast, real money supply and real exchange rate have negative impact on the industrial production index Additionally, the economy is divided by two periods: before and after financial crisis that is represented by dummy variable However, this division cannot explain the economic activities In the short-run, there is only real money supply could be the adjusted parameter for changing of industrial production index

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TABLE OF CONTENTS

ACKNOWLEDGEMENT 3

ABSTRACT 4

TABLE OF CONTENTS 5

LIST OF FIGURES 7

ABBREVIATIONS 9

CHAPTER 1: INTRODUCTION 10

1.1 Problem Statement 10

1.2 Objectives of study 13

1.3 Research questions 13

1.4 Scope of the research 14

1.5 Structure of the thesis 14

CHAPTER 2: THEORETICAL AND EMPIRICAL BACKGROUND 15

2.1 Theoretical background 15

2.2 Empirical review 18

2.3 The conceptual framework 21

2.4 Variables 22

2.4.1 Dependent variable 22

2.4.2 Explanatory variables 24

CHAPTER 3: RESEARCH METHODOLOGY 31

3.1 Research process 31

3.2 Model establishment 31

3.3 Data 34

3.4 Unit root test 35

3.5 Cointegration test 35

CHAPTER 4: DATA ANALYSIS 37

4.1 Industrial production and oil prices 37

4.2 Descriptive analysis 39

4.3 Linear regression model 40

4.4 Augmented – Dickey Fuller (ADF) Test 41

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4.5 Optimal lag length 41

4.6 Cointegration test 42

4.7 Error Correction Model (ECM) 42

CHAPTER 5: CONCLUSION AND POLICY IMPLICATIONS 44

5.1 Conclusion 44

5.2 Policy implications 45

REFERENCES 47

APPENDIX 52

ESTIMATED RESULTS 53

Figure 4.1 The trend of development of industrial production and oil

price in Vietnam

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Figure 4.2 The trend of development of real exchange rate in Vietnam 37

Figure 4.3 The trend of development of real money suppy in Vietnam 37

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LIST OF TABLES

Table 4.1 Summary Statistic on the sample observations 38

Table 4.2 Correlation on the sample observations 38

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ABBREVIATIONS

GDP: Gross Domestic Products

GNP: Gross National Products

CPI: Consumer Price Index

VAR: Vector Autoregression

ECM: Error Correction Model

IPI: Industrial Production Index

OIL: Oil price

RM: Real Money Supply

REER: Real Effective Exchange Rate

IMF: International Monetary Fund

ADB: Asian Development Bank

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CHAPTER 1: INTRODUCTION 1.1 Problem Statement

It cannot be deniable the important role of the energy resource with the human life All economic activities from the smallest unit such as household to the heavy industry use power everyday and the demand for it increasing day by day and one

of the most important among the energy resource is oil In the current economic context with strong level of development, oil is a very important resource for production and has the significant effect to the economic growth

The world has seen the fluctuation of oil prices over the periods and confirmed that oil prices changes have strongly impact on the macroeconomic activities throughout the industrial production index The inflation and recession matters all over the world have related to oil prices changes The increase in oil prices in 1973-1974 and again in 1979 made the mass in the world economy At that time, the prices rose significantly because of strongly shortage in oil supply and high inflation expanded to other industries that made the slowdown in the economy Recent rising

of oil prices is also a reason that makes the economist worry about the prospect of the international finance Additionally, the scarce of natural resource, the current reserve of oil and some conflict about oil in the Middle East are the major problems

for the economic activities According to OPEC report (OPEC annual statistic

bulletin, 2010-2011), more than three-quarters of the world's proven oil reserves are

located in OPEC Member Countries, with the bulk of OPEC oil reserves in the Middle East, accounting for 70% of the OPEC total and OPEC's proven oil reserves currently stand at well above 1000 billion barrels (accounting for 79.6%) While the oil reserves of non-OPEC countries is about 20.41% (about 272.9 billion barrels) With the increasing continuously of exploiting and using oil, the scarce of oil resource cannot be avoidable and the oil prices hardly to fall, which have negative effect on the economic activities, in which the heavy industry is affected as well There are many researches about the relationship between oil prices changes and industrial production index Firstly, oil prices fluctuations impact not only on the

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demand channel but also on the supply channel of industry The supply- side effects are related to the fact that crude oil is the input for the production If there was an increasing in oil prices, the cost of production would be increasing as well, especially in industrial zones The oil prices also affect to the consumption and investment Consumption is affected indirectly to through its positive relationship between oil prices and disposable income The consuming power will be declined if the oil prices rise significantly Furthermore, investment decisions are related to the changes of oil prices because of the increasing in the firms’ production cost Secondly, theory economic suggest that stock prices reflect expectations about the future firm’s earnings Firm’s profit is a mainly part of GDP and its components such as consumption and investment; therefore, when the firms have difficulties with high production cost due to high oil prices, the profit probably fall down lead

to the decreasing in the present value of expected stock dividend while expected stock dividend must ultimately reflect the real economic activities In general, the empirical researches on many countries in the world have showed that oil prices and industrial production index have the negative relationship Based on the result which is found out from the mentioned researches, this thesis is investigating the relationship between the oil prices and industrial production index in Vietnam and answer the question that whether the relationship between oil prices and industrial production index in Vietnam is negative or not

In this paper, analyzing the impact of oil prices on the industrial production index in Vietnam is the main point Vietnam is a country, which has been criticized for its heavy reliance on export of crude oil According to the Vietnam’s oil statistics, Vietnam has an estimated 2,300 million tons of oil reserve Vietnam exports about 16-18 million metric tons of crude oil per year, accounting for almost 20 percent of export earnings This number contribution to GDP stands at about 18-20 percent and about 25-30 percent of government revenues per year However, the problem for Vietnamese economy is that Vietnam export crude oil to the outside with the low price but it has to import petroleum products from the other countries with

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higher price Therefore, when an oil crisis happened, Vietnam would suffer a huge damage because the price of output lead to the increasing in input production cost in industrial zones and other sectors in domestic market

In addition, base on the data regarding the oil consumption from Vietnam’ oil statistics, the consumption of oil in Vietnam is about over 331,000 barrels per day and it is forecasted to keep increasing to 5-7 percent per annum in the end of 2014 However, the current statement of Vietnam’s oil reserves is not good Vietnam opened its first oil refinery plant in quarter 1 in 2009 – Dung Quat refinery and its capacity is at least 140,000 barrels per day of locally produce and imported crude, producing diesel, gasoline, jet fuel, etc This plant is just satisfied only about one-third of Vietnam’s fuel demand lead to the import petroleum products is still a big problem Additionally, Bach Ho oil field is expected to be closed in 2020 If there are no new sources are found, Vietnam will run out of oil and gas resources by

2025

In the beginning of 2011, the world oil price increases quickly that make the domestic firms have to face with the difficulties in rising in production cost, some companies cannot afford to run the business and have to bankruptcy announce From that statement, Vietnam is country that has been potentially vulnerable to oil price volatility The Vietnamese Government (i.e the Ministry of Industry and Trade) has applied many methods to resolve the increasing in oil price in order to prevent the Vietnamese economy from the world crisis In practically, the oil price

is controlled by the Government; therefore, regardless of changing of world oil price, the oil price in Vietnam is quite stable However, although the price is under controlled, the Government still suffers the pressure from the oil companies A specific example is the continuously movement of gas price, the price increases from 2011 until now Along with the increasing of oil and gas, the consumer price index also increases and other bad effects, which make the economy, become a mass

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Throughout analyzing the impact of international oil prices on the industrial production index, the thesis could predict the development trend of the part of the economy Because the definition of economic activities is quite “broad”, in accordance with the research of Yin-Wong Chung and Lilian K Ng (1997) mentioned to the macro variables which are proxies for the measures of aggregate economic activities include the real gross national product (GNP), real money supply and real consumption Additionally, Shahid Ahmed (2008) in his research regarding aggregate economic variables and stock markets in India also referred to the key macro variables which are representing for economic activities such as index of industrial production, exports, foreign direct investment, money supply, exchange rate, interest rate and some other variables Base on that, the scope of this research cannot cover all the above macro variables; therefore, this thesis is just focus on analyzing the impact of oil prices on the industrial production index and recommending some solutions for the oil price in the future

1.2 Objectives of study

The goal of the thesis is to clarify the impact of international oil prices on the industrial production index in Vietnam Specific objectives include:

[1] Investigate the impact of oil prices fluctuation on the industrial production

index in short-run and long run;

[2] Recommend the solution for the economy in order to resolve the current

difficulties and find out the policy for the long-term stable development

1.3 Research questions

To obtain the above objectives, this thesis will attempt to answer the following questions:

[1] Do the international oil prices affect to the industrial production index in

the long-run or in the short-run?

[2] Based on the analysis of oil price impact on the industrial production

index, what will be the proper solutions for the economy?

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1.4 Scope of the research

The research is focus on analyzing the impact of oil price on the industrial production index in Vietnam The data is monthly data, from January 1999 to December 2011 (156 observations) In this research, the industrial production index

is used as dependent variable

1.5 Structure of the thesis

The research consists of five chapters as followings:

Chapter 1 explains reason why the topic of thesis is chosen, significance of the

thesis, main objectives, some major research questions and the scope of the research

Chapter 2 provides an overview on theoretical background of the impacts of oil

prices on the industrial production index

Chapter 3 highlights the research methodology This chapter also describes the

general econometrics model as well as variables and data and outlines the process to analyze data

Chapter 4 shows the statistic results from adopted models Findings are analyzed

and to make clear in reaching objectives and answering the questions in Chapter 1 Results of empirical studies by other researchers are also used to strongly support our findings

Chapter 5 resumes main findings and recommends useful policies for Vietnam in

strategy of economic growth harmony with environment protection This chapter also identifies the limitation and implications for further study

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CHAPTER 2: THEORETICAL AND EMPIRICAL BACKGROUND

This chapter provides an overview about the definition of the factors in the topic such as oil prices, and industrial production index In addition, the empirical reviews have been presented in order to capture the research results of many authors all over the world Furthermore, throughout the empirical study, a conceptual framework is presented and the variables of the model are defined respectively

2.1 Theoretical background

Definition of the oil prices

Oil is an international commodity that every country has to use for production and for daily consumption No country can effectively isolate itself from changes of world oil prices and be affected by the increasing or decreasing of prices and it is linked to all the level of economic activities Therefore, paying attention to the oil prices volatile become the premier conditions for production firms, in specific and for the whole economy in general Oil prices have been variables since the large price increases of the 1970s and 1980s The wide price fluctuations in 2007 and in early 2008 reinforce the idea that oil prices are volatile A numerous research mentioned about the impact of the fluctuation of oil prices on the macro economy all over the world, mainly in United States and in OECD countries (Hamilton 1983,

1996, 2005, 2009, Barsky and Killian 2004, etc.) Numerous researchers suggest that oil price fluctuations have considerable consequences for real economic activity and the oil price volatility also effect on both demand-side and supply-side of the economy In accordance with Robert Kaufmann and Brenda Kuhl, economic activities are often measured by macro variables such as Gross National Product or Gross Domestic Product Additionally, as mentioned in the Introduction part, there are some other macro variables used for representing for the economic activities including industrial production index

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Definition of the industrial production index

Industrial production index is an index which details the growth of various sector in

an economy Industrial production index is an abstract number, its magnitude represents for the status of production in the industrial sector for a given period of time as compared to a reference of time

The Department of Economic and Social Affairs (2010) defines the industrial production index as a factor describes the change of the volume of goods or services produced over times This indicator is very important for assessing the performance

of an economy and a key input for calculating volume measures as part of the compilation of the national accounts In respect of the relationship between economic activities and industrial production index, some authors used the industrial production index proxy for the economic activities when analyzing the effect of oil prices on the whole economy For instance, Lee and Ni (2002) have found that oil prices shock act mainly as supply shocks for oil-intensive industries, such as petroleum refineries, and act mainly as demand shocks for many other industries Additionally, there are some researches about the impact of oil price shocks at the industry level such as Bohi (1989), Kilian and Park (2007)

The impact of oil price fluctuation on the industrial production index

In the research of Robert Barsky and Lutz Kilian (2004), they divided the timing of oil prices shocks into three periods The first period was falling in 1970s, which shows its important role to recognize the impact of oil fluctuation on the macro economy The second stage was notably in the 1986 which see the decreasing in oil prices and the 2000 is the boom of oil prices The oil crisis had been continuing increasing in the 1990-1991 Gulf war and the 2003 Iraq war According to Hamilton (1983), oil price increases seem to be one of the main causes of recessions

in USA prior to 1972 Within a vector autoregression (VAR) framework, Hamilton has found a strong causal and negative correlation between oil price change and real U.S GNP growth from 1948 to 1980 In accordance with Hamilton (1983), the recessions in USD prior to 1972 is mainly caused by the increasing of oil prices

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Using the method of vector autoregression (VAR), the strong relationship between oil prices and U.S GNP growth is found out from 1948 and 1980 Accordingly, oil prices and U.S GNP growth has the causal relationship and negative correlation, therefore, the oil shocks did not have much effect to the real incomes for the economy Additionally, the results from Blanchard and Galí’s research (2007) indicated that the increasing in oil prices have the negative effects to the development of the economy in the early 2000s with the bloom oil Accordingly, Emre C Alper and Orhan Torul (2008) unveiled that the negative impact of oil price changes on the aggregate economic activities is still significant even after

2000

The analyzing of oil prices impact not only in one country but also in many countries in the world Each of country is different from nature of economy, natural resources and other characteristics, however, the researchers have showed a general point is that increasing in oil prices has negative impact on the economic activities throughout the national index such as GDP, CPI, consumption, stock prices, etc There are many researchers from various countries like Mork et al (1994), Valadkhani et al (2001), Papapetrou (2004), Naveed Iqbal Syed (2010) Mork et al (1994) studied about the oil price, GDP relationship in seven OECD countries In this paper, he showed the correlation between oil price movement and GDP fluctuations for seven OECD (United States, Canada, Japan, Germany (West), France, the United Kingdom and Norway) Valadkhani et al (2001) took the example of Australia to assess the impact of oil price changes on consumer goods and services during year 1971-2009 and he saw that when the oil prices increased, the price of related goods and services followed to rise; high inflation and the economic growth fell down Similarly, Naveed Iqbal Syed (2010) studied the case

in Pakistan and Papapetrou (2004) analyzed the case in Greece Additionally, Huang et al (2005) examined the effect of oil price change and its volatility on economic activities in the United States, Canada and Japan Their findings reveal that when oil price change and volatility exceed a threshold, the relationship

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between oil prices changes and industrial production along with stock market returns will be explained strongly

Emre C Alper and Orhan Torul (2008) investigated the effects of oil prices changes

on the real output for a net oil importing small open economy, Turkey Accordingly, this study used a structural VAR approach with the monthly data from 1991 to 2007

in order to analyze the impact of oil prices on the economic activities in Turkey And the findings is that the economy has the negative response to the increasing in oil prices and the fluctuation of oil prices is an important issue for a small open economy such as Turkey

François Lescaroux and Valérie Mignon (2008) in their own research showed the links between oil prices and various macroeconomic and financial variables for a large set of countries The independent variables they used to analyze are GDP, CPI, household consumption, unemployment rate and share prices These indicators represent for the movement of the economy The research results have proved the relationship between oil price fluctuation and the economic activities is negative when the oil price increases day by day in short-run and long run

Xiufang Wang (2010) used the monthly time series from 1992:2 to 2008:8 and the methods of VAR model and variance decomposition analysis to investigate the dynamic relationship among the real economic activities, stock prices and oil prices

in three countries (i.e Russia, China and Japan) His findings showed that three variables have the long-run stationary relationship and the variables have the same trend of development during the sample period In addition, throughout the method

of variance decomposition analysis, the stock prices shocks and oil prices shocks have the impact on the real economic activity In particular, the results present 4.7%

of the variability is explained by the oil shocks and the economy is very sensitive to the changes of in world oil prices However, the percentage of sensitive in the short-run is not as higher as the long-run

2.2 Empirical review

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Ramón Cobo-Reyes et Al in their research in 2005 regarding the effect of oil prices

on industrial production and on stock returns and collected data from January 1963

to May 2004 The model is suggested by Hamilton (1989) in order to analyze the relationship between the variables They depicted the impact of oil prices fluctuation on the industrial production in the Figure 2.1

Figure 2.1 The relationship between increasing in oil prices and the economy

recessions

The results of the research indicate that oil prices and industrial production and stock market have the negative relationship, means that when the oil prices increase, then the industrial production will be decrease respectively Furthermore, after immediate shocking period, increasing in oil prices lead to the three times higher of the stock returns changes compare with the changes of industrial production Nevertheless, four periods after the shift, the order is changed, in particular, the response of industrial production will be two times higher than the response of the

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stock returns before the fluctuation of the oil prices Based on that, the reaction of the stock prices will be faster than the response of the industrial production in the short time, but in the long time, the reaction of industrial production will be higher

In 2006, Komain Jiranyakul studied about the impact of international oil prices on industrial production in Thailand using Johansen cointegration test The author also used the industrial production index to measure the development trend of the economy And the results have showed that the industrial production index will not

be affected by the changing of U.S dollar real exchange rate However, the oil prices and the real money supply have positive impact on the industrial production index It means that when the oil prices increase, the manufacturing sector can adjust itself to higher costs of production in the long run In the short run, industrial production is affected by real money supply, real exchange rate and international oil prices However, any deviation from a stationary long-run equilibrium in the short run will be corrected in a short period The authors find the method to find out the long-run relationship between oil prices, inflation, exchange rate and economic activities Based on the results, the oil prices and the real effective exchange rate have the significant impact on economic activities Furthermore, an increasing in oil prices or depreciation may enhance economic activities and the negative relationship between oil prices and economic activities is proved through their analysis

Komain Jiranyakul in the research which was published on the Munich Personal RePEc Archive in December 2006 has analyzed the impact of international oil prices on Thailand’s industrial production Accordingly, he found that the manufacturing sector can adjust itself to higher cost of production in long run throughout the positive relationship between industrial production index and oil prices In addition, he put some other variables such as US dollar real exchange rate and real money supply into the model and the result is that these two variables have the significant effect to the industrial production index respectively By using firstly the linear regression equation, the research has analyzed the relationship between

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dependant variable and independent with the data collection from January 1990 to December 2004 With this model, Komain used the dummy variable in order to capture the impact of financial crisis and the dummy variable takes the value of zero before the financial crisis from January 1990 to July 1997, and of one thereafter Secondly, for determining whether existence a long-run relationship between the variables or not, the Error Correction Model (ECM) has been applied The result of this study present that the oil prices fluctuations have the negative impact on the industrial production index and the negative relationship could be observed in the short run In the long run, due to an upward trend of oil prices, the Thai economy can be adjusted itself to higher cost of production

In addition, Surender Kumar has showed his result regarding the macroeconomic effects of oil prices shocks in India on the Economic Bulletin, which was, published

on 4th February 2009 by means of multivariate Vector Autoregression Model using both linear and non-linear specifications This research analyses the impact of oil price shocks on industrial production growth for the case of Indian economy for the period from Quarter I of the year 1975 to Quarter III of the year 2004 The results show that the oil prices shocks have the negative impact on the industrial production development, in particular, when the oil prices increase one hundred percent, then, the industrial production index will be decrease by one percent

In this research, I would like to base on the research of Komain Jiranyakul in order

to develop the idea of international oil prices fluctuation on the Vietnamese economic activities I also used both linear regression equation and the ECM to analyze the relationship between economic activities and oil prices However, the period is covered from January 1999 to December 2011 and focus on the Vietnamese case, therefore, there are some significant different from the empirical study

2.3 The conceptual framework

Based on the previous research, the linear regression model and ECM are applied in order to present the relationship between oil prices and industrial production index

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in this paper Moreover, the variable of Real Exchange Rate (RX) will be included

in the model In addition, this paper also uses the dummy variable (D) to avoid the structural break in the data The reason of choosing these variables will be further explained in the next part

The impact of the above variables of the research is shown in conceptual framework

Le Viet Trung, Nguyen Thi Thuy Vinh (2011) In this study, the industrial production index is chosen as the dependant variable for some following reasons:

Linear regression equation and ECM Oil prices

Real Exchange Rate

Real Money Supply

Industrial production

index

Structural break (Dummy variable)

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Firstly, (the Department of Economic and Social Affairs – Statistics Division, 2010)

defined the industrial production index as following: “The industrial production

index measures volume changes in the production of an economy, and therefore provides a measurement that is free of influences of price changes, making it an indicator of choice for many applications While being an important indicator in its own right, the index of industrial production also plays an important role in the national accounts since it reflects the temporal changes in the value added for individual industries, as well as having a strong relationship with the performance

of the economy as a whole For this reason, in many research, the authors used the industrial production index in order to estimate the change of economic activities in the relationship with the other variables”

Secondly, industry is the area that is using the largest oil volume among others

(The International Energy Outlook) said, “Energy is consumed in the industrial

sector by a diverse group of industries, including manufacturing, agriculture, mining and construction and for a wide range of activities, such as processing and assembly, space conditioning and lighting The industrial sector consumed 52 percent of global delivered energy in 2008, and its energy consumption grows by an average of 1.5 percent per year over the projection Industrial energy demand varies across regions and countries of the world, based on the level and mix of economic activity and technological development, among other factors Industrial energy use also includes natural gas and petroleum products used as feedstock to produce non-energy products, such as plastics and fertilizer” For the case of

Vietnam, the economy has grown fast over recent years, energy demand has expanded even faster than the economy, which is increased from 5.187 million toe (tons oil equivalent) in 1990 to 13.128 million toe, indicating an average annual growth rate of 12.3% Additionally, during the 16 years from 1990, energy consumption increased 5.8 times from 5.187 million toe to 30.026 million toe In

1990, the industrial sector accounted for 36% of energy demand while the transportation sector for 36% and other sectors for 28% These shares changed to

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the respective levels of 47%, 30% and 23% in 2006 While the industrial sector’s share of total energy demand expanded fast, the shares for the transportation and other sectors shrank Based on that, the fast energy demand expansion reflected the industrial sector’s robust development and energy demand growth in the other sectors was relatively slower The development trend is depicted as the Figure 2.3

Figure 2.3 Economic development and energy trend in Vietnam

2.4.2 Explanatory variables

Beside variable oil prices, which under the chosen models, some other explanatory variables comprise in the research to explain more exogenous influence on the industrial production index They are real money supply, real exchange rate and the dummy variable for structural break in data collection The reasons for using these variables are detailed as following:

Firstly, the oil prices may affect industrial production index indirectly through the other important transmission channels, in part by inducing changes in economic policies Those channels include effects of oil prices on the money supply to the economy and exchange rates, which then induce changes in real economic activities

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Secondly, using the multivariate modeling framework instead of bivariate one is to avoid the case of omitting the variable bias In addition, a lot of working research regarding the impact of oil prices on the economic activities using the other variables for analyzing

Oil prices

The research is using the international oil prices instead of national oil prices The reason is that national oil prices have been influenced by price-controls, exchange rate fluctuations and national price index variation Therefore, most of the empirical literature analyzing the effect of oil price on the economic activities that used the world price of oil as a common indicator to measure the level of impact such as Mork, Olsen Mysen, Hamilton, JC Nkomo, Hussain A Bekhet, Nora Yusma

Mohamed Yusop, etc (cited from Berkeley (2012) Energy prices and real economic

activity)

Many researchers, including Burbidge and Harrison 1984, Bernanke et al 1997, Hamilton 1983, Hamilton and Herrera 2001, Hamilton 2003, and Gisser and Goodwin 1986 have the conclusion that the oil prices have the negative relationship with the economic in United States In particular, when the oil prices increase, then, the economic in United State will be downturn In addition, some other researches for a lot of countries around the world have found out that there are strong correlation or co-integration relationship between international oil prices and macroeconomic variables in the long run The authors are Boukez 2007, Jones et al

2004, Hamilton 2003, Rodrigues and Sanchez 2004; Davis et al 2005)

The main purpose of this research is analyzing the impact of oil prices on the industrial production index However, besides the effect of oil prices, the research will include two other variables (i.e real effective exchange rate and dummy variable of financial crisis) to find out the impact of them on the economic activities

Real Money Supply (RM)

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In recent years, the researchers all around the world pay much their attention to the relationship between money supply and economic growth Many studies such as Friedman and Meiselman 1963, Sim 1972, Weclock 1996 have found out that

money supply has the positive relationship with the economic growth (cited from

M S Ogunmuyiwa and A Francis Ekone (2010), Money supply – Economic growth Nexus in Nigeria) Accordingly, when the real money supply increases, the

economy will expand and thus causes arising in industrial production

Real Effective Exchange rate (REER)

In consideration of analyzing the impact of real exchange rate on the output, some research have been made with cross-country data and some have made with single country data The results find that devaluations have a negative impact on the output Contrast effects of devaluation that slow output growth also appear in the majority of twenty two developing countries under the investigation by Kandil 2003; Edwards 1986; Kamin and Klau 1998, etc

To examine the effect of changes in the real exchange rate on output of a single country, Muhammad Jamil, Erich W Streissler and Robert M Kunst have used the pooled data regression to prove the significant impact of real exchange rate volatility on the industrial production

Measuring Real Effective Exchange rate (REER):

d

e d REER

1

,

) (

Where:

N is the number of trading partners with Vietnam

e i,j is the exchange rate between VND v.s currency of trading partner i Because the

direct exchange rate between VND and respective trading partner is not available, therefore, the exchange rate of VND/USD and respective currency/USD are converted The data on exchange rate is extracted from IFS

Where e CU/USD is the exchange rate between respective currency v.s USD

w i is the trade weight of economy i with Vietnam; d j and d i are CPI of Vietnam and

trading partner i, respectively

Dummy variable of financial crisis

The financial crisis is divided from two periods: the first period is from January

1999 to December 2007 and the second period is beginning from January 2008 The value of zero will be attached to the first period and the value of one will be for the other

Vietnam joined WTO by the end of 2006 result to a boom of investment, trade and financial and banking activities And one year later, the Vietnamese economic is expected to develop higher and higher However, because of too fast growth, then, stability of the economy is considered to be broken For the period from March

2008 to July 2008, the Vietnamese economic was under the worsening situation: Before the global crisis, Vietnam has to face the financial crisis of currency Accordingly, the banking system was lack of liquidity, the depreciation of Vietnam Dong happened in the early of May and June 2008, and it was predicted that further Vietnam Dong depreciation could be happened lead to facing of high inflation and unstable balance of payments In addition, there are some another ideas that Vietnam has not been in financial crisis, but facing with some serious macroeconomic problems because of high inflation Additionally, a fragile financial system and unstable balance of payments deficit are the main factors causing the Vietnamese crisis However, there are different thoughts of Vietnamese economy situation regarding assessment of the risks magnitudes and problems Furthermore, stabilizing Vietnamese economy will be a difficult and multi-faceted task lead to a huge challenge for the Government in issuing the perfect policy strategy Thus, the

28

period of economic crisis in Vietnam could be counted from 2008 The Table 2.1 will summarize the variables and the expected signed in accordance with the empirical researches

Table 2.1 Summary of variables

Variables Description Expected

sign Main empirical reference IPI Industrial Production

Index

Komain Jiranyakul (2006), Surender Kumar (2009), Huson Joher Ali Ahmed, Omar H.M.N Bashar, I.K.M Mokhtarul Wadud (2011), Le Viet Trung, Nguyen Thi Thuy Vinh (2011)

OIL Oil price

-

Hamilton 1983, Burbidge and Harrison 1984; Gisser and Goodwin 1986; Mork 1989; Hamilton 1996; Bernanke et al 1997; Hamilton and Herrera 2001, Boukez 2007; Hamilton 2003; Rodrigues and Sanchez 2004; Davis et al 2005; and Eng & Keong 2004

+ Komain Jiranyakul (2006)

RX Real Money Supply

+

Sim 1972; Weclock 1995; Friedman and Meiselman 1963

REER Real Effective

Kandil 2003; Edwards 1986; Kamin and Klau 1998, Muhammad Jamil, Erich W

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Streissler and Robert M Kunst