Multivariate granger causality and the interrelationship between foreign direct investment, gross domestic investment, inflation, and exchange rate in vietnam

Nội dung text: Multivariate granger causality and the interrelationship between foreign direct investment, gross domestic investment, inflation, and exchange rate in vietnam

1. MULTIVARIATE GRANGER CAUSALITY AND THE INTERRELATIONSHIP BETWEEN FOREIGN DIRECT INVESTMENT, GROSS DOMESTIC INVESTMENT, INFLATION, AND EXCHANGE RATE IN VIETNAM Wann-Yih Wu1 1Department of Business Administration,Nanhua University No. 55, Sec. 1, Nanhua Rd., Dalin, Chiayi, 62249, Taiwan Tel: +886 933 66 57 81 Email: wwanyi888@gmail.com Phan Thi Phu Quyen2 2Department of Marketing, Da Nang University of Economics, The University of Danang 71 Ngu Hanh Son Street, Ngu Hanh Son District, Da Nang City, Vietnam Tel: +84 935 915 987 Email: phuquyen.due@gmail.com Corresponding author: Phan Thi Phu Quyen Da Nang University of Economics No. 71, Ngu Hanh Son Street, My An, Ngu Hanh Son, Da Nang, VIETNAM Email: phuquyen.due@gmail.com Tell: (84) 935 915 987 ABSTRACT The paper aims to analyze the impact of the exchange rate and inflation on foreign direct investment (FD) and its relationship with the economic growth (GDP). The main objective is to find the effect of inflation and exchange rate and the directionality between foreign direct investment and economic growth in Vietnam.The data cover the time period from 1985 to 2015 for this paper. The four variables are found to beI(1) series by employing the Augmented Dickey-Fuller and Phillips-Perron unit root tests and to be co-integratedby using the Johansen method. The Granger causality test is thus performed in thecontext of the estimated vector error correction (VEC) model. The result indicates that there is a bio- directional causality between FDI and Inflation (CPI), while exchange rate movement (is measured by PPP) causes FDI inflows growth.In addition, when FDI increases, the GDP of Vietnam will be positively affected by FDI. 419
2. 1. Introduction FDI refers to net inflows of investment in an economy of a nation. It has become one of the most populartoolsof economic growth in developing countries (Khan, 2007). FDI is needed to reduce the difference between the desired gross domestic investment and domestic savings. Jenkin and Thomas (2002) assert that FDI is expected to contribute to economic growth not only by providing foreign capital but also by crowding in additional domestic investment. By promoting both forward and backward linkages with the domestic economy, additional employment is indirectly created and further economic activity stimulated.According to Adegbite and Ayadi (2010), FDI helps fill the domestic revenue‐generation gap in adeveloping economy, which most developing countries’ governments do not seem to be able to generate sufficient revenue to meet their expenditure needs. Other benefits enable the employment, exploitation of natural, and human resources, or implement innovative business practices, in term of management and marketing, and facilities in reduction of budget deficit. The beginning of the Vietnam’s impressive economic growth was marked when the reform policy, which called Doi Moi, was introduced in 1986. The reform process has resulted in a general rise in the standard of living in Vietnam as measured by Gross Domestic Product (GDP) or economic growth. GDP reveals to the market value of all final goods and services produced within a country in a given period.There is also vast number of researches regarding to FDI in Vietnam. For example, Mai (2003)and Freeman (2002) found the effects of FDI in processing industries. However, Nguyen and Nguyen (2007) have conceded that the literature on Vietnam is still in its infancy. Moreover, the two-way linkage between FDI and economic growth in which FDI promotes economic growth and, in turn, economic growth is viewed as a tool to attract FDI is not thoroughly investigated. Additionally, since Vietnam has entered WTO, as well as the world’s economy has been heavily suffering from the economic recession, which has significant hit Vietnam’s economy in general and foreign investment in particular; there is yet a few of research the impacts of Foreign investment activities on Vietnam’s economic growth. This study attempts to fill this gap in the existing literature, as well as to review and analyze the relationship between FDI and GDP in the context of Vietnam in integration period. Secondly. FDI is a major component of capital flow for developing countries, its contribution toward economic growth is widely argued, but most researchers concur that the benefit outweighs its cost on the economy (Musila & Sigue, 2006). Furthermore, an economic policy that can provide a conductive economic environment that will help to attract FDI inflows into the country is desired. Nevertheless, according to Kiat (2008), the characteristic of monetary policy presented the impossible trinity, that is a trilemma issue where trade-off must be done in order to maintain economic stability. Two of these problems are inflation autonomy and exchange rate variability. This trade-off can impact on the FDI inflow.De Mendonca (2007) explored that the adoption of inflation targeting is a good framework for reducing inflation. Additionally, FDI theory based on exchange analyses the relationship of FDI flows and exchange rate changes. Most businesses encourage foreign direct investment where foreign currency is expected to appreciate against their domestic currency. This relationship is debating when some findings showed a positive effect exchange rate on FDI 420
3. and other findings suggested a negative effect. Therefore, this research attemptsto fill this gap in the existing literature. This study examines the relationship between foreign domestic investment (FDI), gross domestic product (GDP), inflation (CPI), and exchange rate (PPP). The data are collected the period of 1985 to 2015. The time-series methods employed in this study include unit- root tests, co-integration tests, vector error correction (VEC) models, and Granger causality test. This paper is divided into five parts. Section I above is the introduction. Section 2reviews the relevant literature. Section 3discusses the data and methodology employed in this study. Section 4is empirical results, while Section 5 discusses conclusions. 2. Literature Review Following to the eclectic theory of FDI, developed by Dunning (1988), provides an alternative tool to analyze the relationship between FDI and economic growth. Based on location advantages, many empirical studies have found that economic growth is an important determinant of FDI. These studies provide sample evidence of a link between FDI and economic growth in both developed and developing nations, few studies have considered the role of FDI in promoting economic growth within different regions of developing countries.Anwar and Nguyen (2010) surveyed the link between foreign direct investment and economic growth for61 provinces of Vietnam from 1996 to 2005. Their empirical results confirmed that an increase in the stock of FDI increases Vietnam’s economic growth rate, which attracts further FDI into Vietnam. Based on the energy- growth literature, Tang et al. (2016) found that foreign direct investment is one of important variables that positively influence economic growth in Vietnam.Tsai (1994) argued a simultaneous system of equations to exam two- way linkages between FDI and economic growth for the period of 1985 to 1978 in 62 nations and for 52 nations from 1983 to 1986. Bende-Nabende et al. (2001) showed that economic growth had also a significant effect on attracting FDI to the region. Low inflation rate is considered to be a sign of internal economic stability in the host country, while high inflation rate shows incapability of the government to balance its budget. If a country experience a high inflation rate relative to other countries then its demand for goods decrease which will decrease the foreign direct investment in the country. Inflation found to be a good economic indicator for the economy. Thus, it is perceived as a vital effect toward foreign direct investment. In the study ofSaleem et al. (2013) investigated the effect of inflation on foreign direct investment during the time period of 1990 to 20011 in Pakistan The results suggested that there was a positive relationship exists between foreign direct investment and inflation. Narendra (2014) confirmed the positive effect and significant impact of inflation on FDI inflows.In addition, when there is an increased foreign direct investment it put an upward pressure on the local currency that will negatively affect the exporting industries due to there is a possibility of increase in inflation. Jin et al. (2008) indicated that FDI inflows lead to inflation. Emernyeony and Ucal et al. (2010) investigated that foreign direct investment related positively with inflation rates. Nevertheless, there are different opinions about the relationship of foreign direct investment and inflation. Omankhanlen 421
4. (2011) explored the relationship between inflation and foreign direct investment in Nigerian, using the OLS regression model for the period 1980 to 2009. Evidence demonstrates that inflation rate did not have major effect on the inflow of FDI into the Nigerian economy. Faille (2011) and Lawarence (2011) also supported that FDI inflows do not lead toward inflation. Linking inflation to economic growth, an observation of the long- run relationships among GDP, FDI, and inflation from 1970 to 2008, Ercakar (2011) found that FDI, inflation have positive and significant effect of GDP growth. A study of Odhiambo (2010), the causal relationship between inflation, investment and growth was examined in the period of 1990 to 2009 in Tanzania, the empirical result concluded that there is a unique integrating relationship between inflation and growth. Chih (2009) tested the causal interrelationship between inflation and economic growth across sectional data of 140 countries over the period of 1970 to 2005. The results showed that inflation is harmful to growth, whereas the effect from growth to inflation is beneficial. The exchange rate is also a basically factor of macroeconomics that impact on Foreign Direct Investment inflow. Real exchange rate is viewed as a result of inflation. In the long run, real exchange rate is believed to be the function of the level of thedevelopment of a country. Therefore, economist often use Purchasing Power Parity (PPP) rate to explain the equilibrium exchange rate in poorer countries.The higher exchange rate means that price of foreign currency has appreciated and local currency has depreciated. If there is an increase in the price of foreign exchange, it will raise the cost of purchasing foreign goods. Ezirim et al. (2006) explored that FDI had a positively effect on exchange rates and inflation rates. Based on these results, Coleman and Tettey (2008) investigated the effect of exchange rate on foreign direct investment. They explored that exchange rate had a negative effect on FDI inflows. Rashid and Hafeez (2012) analyzed and found that there are two way causality relationships between FDI and exchange rate. This study attempts to comprehensively assess the relationship of economic growth, inflation, exchange rates, and Foreign Direct Investment for Vietnam by using the Granger causality test in the context of the vector error correction model with the eight variables aforementioned. 3. Data and Methodology Data analyzed for this study were those significant in the attraction of FDI into the host countries, as well as those relating to the measurement of the impact of FDI in the host countries over the years. The data and their relationships are defined thus: (a) Gross Domestic Product (GDP): This is usually employed to denote market size, which is indicative of the level of economic activity. A large market size is suggestive of a prosperous business climate and hence serves as a factor a (b) Foreign Direct Investment (FDI): Capital investment (other than portfolio investment) made to acquire a long term controlling interest in a firm operating in another country other than that of investors’ country. (f) Inflation Rate (INF): Inflation when the price of most goods and services produced within a country in a given period. It is measured by the consumer price index (CPI). 422
5. (g) Exchange Rate (EXR): It is calculated the real exchange rate indices of the respective currency against the U.S dollar by using the purchasing power parity (PPP) approach. By adjusting real exchange rates for inflation, the study can get a more correct PPP deviation measurement because the inflation in the emerging markets is comparatively larger and more unstable than in the developed economies expensive and export cheap, and hence may likely impact positively on FDI. This study investigates the relationship between FDI and microeconomic factors with an application of the time-series method to the annual data on FDI, GDP, CPI, and PPP in Vietnam from 1985 to 2015. The uni-root test is first employed to test for stationary and the order of integration of the four series variables LNFDI, LNGDP, LNCPI, and LNPPPin the 31 years. If they have one unit root and are co-integrated, the bi-variate vector error correction model (VECM) is specified and estimated. The Granger causality test is then conducted in the dynamic system of VECM. If the four series have one unit root but are not co-integrated, then the bi-variate vector autoregressive model (VAR) is employed and estimated for both variables in their first difference. The Granger causality test is then conducted in the context of the VAR model 3.1 Unit Root Test A stationary series has a constant mean, a constant variance and a constant auto covariance for each given lag. In case the series is nonstationary with n roots, nth differencewould be conducted until it becomes stationary. Nevertheless, crucial risk involves losing the long-term relationship possibility when taking differences to make series stationary, implying that optimal series can be I(0) or for a suitable conditions it can be I(1) (Granger, 1969). As the result, this study performs the Augmented Dickey-Fuller (ADF) (Dickey and Fuller, 1979) tests to investigate stationarity properties of each variable in order to avoid any spurious regression.Augmented Dickey-Fuller (ADF) test consists of running a regression of the first difference of the series against the series lagged once, lagged difference terms, and optionally, by employing a constant and a time trend. 3.2 Cointegration Test Furthermore, the time series has to be examined for co-integration. Co-integration analysis helps to identify long-run economic relationships between two or several variables and to avoid the risk of spurious regression. Co-integration analysis is crucial because if two non-stationary variables are cointegrated, a Vector Autoregression (VAR) model in the first difference is misspecified due to the effect of a common trend. If a cointegration relationship is identified, the model should include residuals from the vectors (lagged one period) in the dynamic Vector Error Correcting Mechanism (VECM) system. The cointegration test employed in this paper is the Johansen test developed by Johansen and Juselius (1990). There are two tests in the Johansen method, i.e., the trace test and the maximum eigenvalue test. If the test statistic is greater than the critical value, then the null hypothesis that there are r cointegrating vectors is rejected in favor of the alternative hypothesis that there are r+1 cointegrating vectors for the trace test. The testing is performed in a sequence under the null hypothesis that r=0, 1, , k-1 if there are k variables under investigation. Johansen and Juselius (1990) indicated that the trace test might lack power relative to the maximum 423
6. eigenvalue test. Based on the power of the test, the maximum eigenvalue test statistic is often preferred. 3.3 Vector Autoregressive Model The vector autoregressive model (VAR) is a system incorporating k variables in time t treated as dependent variables on the left hand side of each of the k equations and all variables in time t-1, t-2, , t-m treated as independent variables on the right hand side. There is no need to make distinction between endogenous and exogenous variables because all are treated as endogenous. It is noted that all variables in the VAR model should be stationary series. Each equation of the VAR model can be estimated using the OLS method since all the variables on the right hand side are lagged and thus can be treated as exogenous. 3.4. Vector Error Correction Model When the nonstationary variables under investigation are found to be cointegrated, the vector error correction (VEC) model will be performed for them with the error correction term included in the VAR model. The dynamics of the VEC model’s specification enable to force the long-run behavior of the endogenous variables to converge to their cointegrating relationships, while accommodating short-run dynamics. It is suggested deleting the insignificant variables until a regression with all its coefficients statistically significant will be obtained. The error term in the VEC model is used to correct a deviation from equilibrium toward long-term equilibrium. The VEC model is a system incorporating k variablesin time t treated as dependent variables on the left hand side of each of the k equations and all variables in time t-1, t-2, , t-m as well as the error term in t-1 treated as independent variables on the right hand side. Each equation of the VEC model can be estimated using the OLS method. The VAR model and the VEC model are employed in this paper to conduct the Granger causality test. 3.5 Granger Causality Test The Granger causality test will be performed on the four series in the context of the VAR model or the VEC model. Engle and Granger (1987) argue that, if cointegration exists between two variables in the long run, there must be either unidirectional or bi-directional Granger causality between these two variables. Engle and Granger also argue that the cointegrated variables must have an error correction model representation. As mentioned above, if the four series data have one unit root and are cointegrated, then the bi-variate vector error correction model (VECM) is specified and estimated. Granger causality test is then conducted in the context of the VEC model. If two series have one unit root and are not co-integrated, then the bi-variate vector autoregressive model (VAR) is specified and estimated. Granger causality test is then conducted in the context of the VAR model. 4. Empirical results The estimates of the Augmented Dickey – Fuller (ADF) test in levels and in first differences of the data with an intercept, with an intercept and trend and with no intercept or 424
7. trend. The tests have been performed on the basis of 5 percent significance level, using the McKinnon Critical Values. Firstly, ADF test with an intercept implies that all variables are not stationary at levels even at 10 percent level of significance. Similarly, the test with an intercept and trend at levels presents no significance at any accepted significance level. On the other hand, at 1st differences all variables are integrated of order one. ADF test with no intercept or trend reports that at levels none of the examined variables has a unit root. Collectively, at 1st differences, all four variables are stationary at 1 percent. The first difference denotes percentage changes in or growth of that variable. Therefore, DLNFDI denotes real FDI growth, DLNGDPreal GDP growth, DLNPPP real exchange real movement, DLNCPIinflation. Thus, robust results indicate that all variables are integrated of order one i.e. I (1) for the case of Vietnam. The Johansen test is applied to detect whether the four variables are co-integrated or whether they have the long-run equilibrium relationship.The trace test and the maximum test are mutually applied to detect whether the series in the model are co-intergrated. The series are LNGDP, LNCPI, LNFDI, LNPPP. Table 1 provides the results from the application of Johansen cointegration test among the data set. The tables indicates that the null of at most 3 co-integrating equations is not rejected for the trace test because the trace statistic is found to be 0.174 somewhat below the 5% critical value 3.8414. The maximum eigenvalue test provides the same result in the sense that the null of at most 3 co-integrating is not rejected based on the test statistic 2.5932 well below the 5% critical value 3.8414. It is concluded that there exist three co-integrating equations among the four series. Table 1: Johansen Co-integration Test results Null Trace 5% Critical Maximum 5% Critical Hypotheses statistic Value Eigen value Value statistic r* = 0 132.4057 47.85613 63.59969 27.58434 r ≤ 1 68.80600 29.79707 52.93854 21.13162 r ≤ 2 15.86746 15.49471 15.69343 14.26460 r ≤ 3 0.174025 3.841466 0.174025 3.841466 Table 2 documented the causality tests as performed using the VECM approach. Evidence from the Granger causality test shows that exchange rate movement and inflation directionally caused FDI inflows growth. In addition, there is a significant linkage between foreign direct investment growth and inflation running from FDI to CPI. It is clearly found that Foreign Direct Investment bidirectionally cause inflation. Furthermore, the strong effect of foreign direct investment on gross domestic product growth is explored, whereas economic growth is an insignificant influence on FDI.Nevertheless, the indirectly influenceof inflation on gross domestic product through FDI is not found in the case of Vietnam.In the other hand, inflation causal linkages GDP growth is not confirmed 425
8. Table 2: Results from the Granger Causality Test Chi-square Degree of Probability Statistic Freedom Panel A DLNFDI Granger caused by LNCPI 8.057 1 0.0448 LNPPP 11.705 1 0.0085 Panel B DLNCPI Granger caused by LNFDI 8.434 1 0.0378 Panel C DLNGDP Granger caused by LNFDI 35.3561 1 0.000 Notes: Those significant at the 1%, 5%, and 10% levels are reported. 5. Conclusion This study has explored the possible relationship between FDI flows into Vietnam, exchange rate, inflation, and Gross Domestic Product, using annual data over 31 years from 1985 to 2015 by time series methods. It is found from the unit root test that all the series are nonstationary with one unit root test. The Johansen cointegration test is then applied on the four series and there are three cointegrating equations are found. The results indicate evidence of number statistically significant linkages in the long run in the case of Vietnam. Firstly, foreign domestic investment is explored to bi-directionally cause inflation. The results of the empirical study found that price stability might attract FDI because of the directional causality from FDI to inflation. In turn, the effect of inflation on FDI signifies that high inflation deters FDI in Vietnam. High FDI is central to low level of inflation in Vietnam. Secondly, the paper enhances the understanding of the real effects of exchange rates in Vietnam market. The empirical findingexplores that there are a positively effects of the real exchange appreciation of the host country on the FDI inflows. The outcome of this study suggests that Vietnam’s authorities should enhance and implement measures that will ensure that the increasing level of inflation and exchange rates will increase the volume of FDI inflows. Lastly, the results reveal that FDI has a significant and positive effect on economic growth. increase flow of FDI has given a major boost to the country’s economic, which will help to increase GDP rate. This result is consistent with Anwar and Nguyen (2010), thus providing the fact that when FDI increase, the GDP on Vietnam will positively affected by FDI. Therefore, Vietnam government should positively concentrate on maximum utilization of resources and performFDI attractive policies to increase FDI in order to raise GDP growth rate. Nevertheless, there is no empirical evidence to support the notion that economic growth has been pivotal to foreign direct investment in Vietnam, which could have justify economic growth is a major contribution to FDI inflows of the nation. 426
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