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• Study examines:Do unrequited transfers: Aid & remittances affect real exchange rates (RER) ?

• Nominal exchange rate (NER): units of foreign currency per unit of domestic currency (DC) .

• RER= NER (pd/pf)

where pd = dom. price level & pf = world price level

• Rise in value of DC & ER rate mean the same

• Dutch disease: RER appreciates with increasing Aid & REM hurting exports competitiveness

• PNG : outlier with large resources: excluded

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The term Dutch disease: refers to “unintended negative impact of a resource boom on a country’s non-resource tradable sector”,

Term: Rise in the appreciation of the Dutch currency in 1960s: surge in the foreign exchange: Discovery of the North Sea gas fields in the Dutch economy

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• Earnings spent within the economy lead to rise in price of non-tradables: water, electricity, land & services

• Rise in dom.price level & increase in RER hurting competitiveness of exports

• Term: Dutch disease is extended to cover impact of unrequited capital transfers on export competitiveness as well.

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PICs :price takers: prices of traded goods are fixed in world markets.

Increase in domestic expenditure results only in rise in prices of non-traded goods

Relative price change leads to change in composition of output

Output in traded goods sector contracts

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Two major channels

Inflows of aid and remittances are expected to result in a spending effect causing an increase in consumption of tradables and non-tradables

Prices of tradables determined outside

Relative prices of non-tradables increase

Boosting domestic price level.

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Higher RER both fueling and fueled by a resource movement effect

Rising non-tradable prices shift resources from production of tradables to non-tradables

These shifts exert upward pressures on wages & production costs, & the overall dom price level

Resulting appreciation in RER (= NER(pd/pf) hurts export competitiveness

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There is also the effect flowing out of consumption-leisure tradeoff

Leisure is preferred as remittances rise

Reduction in overall supply of labour

Growing demand: higher consumption due to remittance: reduction in labour supply: further price increases in non-tradable sector.

Rise in pd result in REER appreciation

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Year Fiji SamoaSol.

IslandsTonga Vanuatu

1980-1989 (Ave) 3.27 25.52 24.35 23.52 29.97

1990-1999 (Ave) 2.85 10.58 14.64 16.56 20.192000-2004 (Ave) 1.95 11.27 17.62 11.10 12.65

2005-2009 (Ave) 1.87 9.56 46.93 9.82 13.272010 2.51 23.12 68.57 18.45 11.802011 2.15 13.91 50.47 20.59 13.822012 2.80 15.73 32.74 16.68 16.022013 2.22 15.49 27.42 18.28 11.402014 2.12 11.96 18.05 18.20 12.07

Aid as percent of GDP

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Year Fiji Samoa Sol Is. Tonga Vanuatu

1980-1989 (Ave) 1.66 25.09 NA 23.14 6.63

1990-1999 (Ave) 1.55 21.83 0.49 18.10 7.61

2000-2004 (Ave) 4.95 16.61 1.34 31.15 7.47

2005-2009 (Ave) 5.73 17.93 2.03 27.16 1.372010 5.33 21.09 2.13 20.89 1.682011 4.25 20.95 1.91 17.84 2.752012 4.80 22.10 2.02 25.72 2.822013 4.85 20.68 1.95 27.95 2.962014 4.65 17.55 1.41 26.29 3.45

Table 2: PICs: Remittances (percent of GDP): 1980-2015

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REER Index ( Base: 2010=100) : 1980-2014

Year Fiji Samoa Sol. Is Tonga Vanuatu 1980-89(Ave)

67.0 109.5 86.7 168.6 107.4

1990-99 (Ave) 83.8 126.8 90.4 89.1 95.9

2000-04 (Ave) 91.5 126.9 99.5 84.8 104.0

2005-09 (Ave) 88.0 109.0 103.3 93.5 104.4

2010 100.0 100.0 100.0 100.0 100.0

2011 96.7 99.1 97.0 106.0 101.5

2012 93.8 97.1 88.8 106.7 102.4

2013 92.9 95.5 82.5 108.1 98.7

2014 93.8 95.5 78.0 103.8 94.6

Source: IMF(except Tonga and Vanuatu); authors' calculations11

Exports of PICs as (% of GDP)

Year Fiji Samoa Sol Is Tonga Vanuatu

1980-89 46.9 NA 34.9 26.3 41.8

1990-99 51.8 29.4 35.4 21.3 44.9

2000-09 56.0 29.2 31.3 15.9 43.0

2010 57.8 29.2 50.0 12.7 46.6

2011 59.3 28.7 61.1 16.8 44.3

2012 61.0 27.7 62.0 19.5 49.1

2013 56.6 30.3 56.4 21.2 47.8

2014 54.8 28.2 NA 17.8 48.0

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Exports of PICs as % of their imports : 1980-2014

Year Fiji Samoa Sol Is Tonga Vanuatu

1980-1989 62.5 26.6 86.1 15.5 38.3

1990-1999 61.5 10.2 98.2 19.2 36.1

2000-2004 57.0 11.6 74.5 14.3 33.0

2005-2009 41.8 5.6 58.8 6.9 28.7

2010 46.3 4.9 73.8 5.2 26.8

2011 49.0 5.3 86.4 9.0 26.5

2012 54.3 11.1 112.6 8.7 27.0

2013 39.3 7.4 96.5 11.1 27.4

2014 34.1 NA 98.9 10.3 28.2

Source: WDI13

Testing Aid & Rem positively affect REER

Trade weighted REER rate from IMF

Data constraint: Min. number of variables.

Policy variable: capturing effects of fiscal & monetary policies on REER: domestic credit as ratio of GDP

Expansionary policies influence REER

No a priory conclusion on direction (+ or -)

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Domestic Credit by ( % of GDP) :1980-2014

Year Fiji Samoa Sol.Is Tonga Vanuatu

1980- 89(Ave) 33.2 15.8 24.5 24.7 23.3

1990-99(Ave) 41.8 5.6 24.4 31.5 32.8

2000-04 (Ave) 79.8 25.5 33.8 40.5 40.6

2005-09 (Ave) 124.3 50.9 34.0 47.7 47.8

2010 132.3 63.9 27.2 40.3 63.7

2011 115.6 62.7 14.1 29.9 67.7

2012 114.4 61.2 11.8 27.0 70.0

2013 111.9 67.2 21.0 28.6 68.7

2014 113.1 77.4 22.2 29.5 72.115

Sign of Dom.Credit: positive or negative.

If policy measures would lead to rise in supply of non-tradables, there would be fall in domestic inflation

That will result in REER. Negative sign

On the other hand, if economic policies are inflationary, there would be a rise in REER, given world price level.

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• The model for estimation purposes is written as follows:

REERi,t = β0 + β1 AIDi,t + β2 REMi,t + β3 DOMCREi,t + εi,t

• where REER: Real exchange rate in index number;

• AID = aid as percentage of GDP;

• REM = remittance inflows as percent of GDP;

• DOMCRE= domestic credit as percent of GDP;

• εi,t = white noise error term. 17

Panel Unit Root and Stationary Tests:

Maddala and Wu (1999), Hadri (2000), Levin et al. (2002) and Im et al. (2003)

Panel Cointegration

Pedroni (1999, 2001, 2004) and Kao (1999) panel cointegration tests.

Pedroni (1999, 2001, 2004) considers

seven different statistics

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Panel Fully Modified OLS (FMOLS) Estimates

The FMOLS procedure accommodates the heterogeneity that is typically present both in the transitional serial correlation dynamics and in the long run cointegrating relationships.

TEST RESULTS ON REQUEST

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Six out of seven Pedroni statistics: establish cointegration

The estimated long run estimated panel equation :

REER = 0.194 AID +0.298 REM – 0.471 DOMCRE

(3.651) (4.232) (-6.096)

Variables are in logs

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Estimated coefficients: elasticities

1% rise in AID results in 0.2% increase in REER.

1% in rise in REM leads to 0.3%rise in REER

Expansionary policies result in rise in non-trables supply: fall in REER:

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A panel study: 5 PIC which have currencies of their own: Fiji, Samoa, Solomon Islands, Tonga and Vanuatu.

Many commonalities: A panel study: 1980-2014

Variables: REER in Index; aid & remittances as % of GDP; & policy variable: Domestic credit as % of GDP

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Finding: Existence of strong evidence in favour of significant & direct association with aid & remittance inflows and appreciation of domestic currency

Phenomenon of Dutch disease hurting the attractiveness of its exports operates

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Increase output of non-tradables & import substitution wherever possible

Focus on dom. production of vegetables, fruits and milk

PICs: large areas of arable land unutilized

Emphasis should be on lessening domestic inflation.

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THANK YOU

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It was six men of Hindostan

To learning much inclined,

Who went to see the Elephant

(Though all of them were blind),

That each by observation

Might satisfy his mind.