Applied Economics

ISSN: 0003-6846 (Print) 1466-4283 (Online) Journal homepage: https://www.tandfonline.com/loi/raec20

Impact of oil price shocks on output, inflation and

the real exchange rate: evidence from selected
ASEAN countries

Hem C. Basnet & Kamal P. Upadhyaya

To cite this article: Hem C. Basnet & Kamal P. Upadhyaya (2015) Impact of oil price shocks on
output, inflation and the real exchange rate: evidence from selected ASEAN countries, Applied
Economics, 47:29, 3078-3091, DOI: 10.1080/00036846.2015.1011322

To link to this article: https://doi.org/10.1080/00036846.2015.1011322

Published online: 12 Feb 2015.

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Applied Economics, 2015
Vol. 47, No. 29, 3078–3091, http://dx.doi.org/10.1080/00036846.2015.1011322

Impact of oil price shocks on

output, inflation and the real
exchange rate: evidence from
selected ASEAN countries
Hem C. Basneta and Kamal P. Upadhyayab,*
a
Chadron State College, Chadron, NE 69337, USA
b
Department of Economics, University of New Haven, West Haven, CT
06516, USA

This article analyses the impact of oil price shocks on real output, inflation
and the real exchange rate in Thailand, Malaysia, Singapore, the Philippines
and Indonesia (ASEAN-5) using a Structural VAR model. The cointegra-
tion tests indicate that the macroeconomic variables of these countries are
cointegrated and share common trends in the long run. The impulse
response functions reveal that oil price fluctuations do not impact the
ASEAN-5 economies in the long run and much of its effect is absorbed
within five to six quarters. The variance decomposition results further assert
that with a few exceptions oil price shocks do not explain a significant
variation in any of the variables under consideration. We also identify a very
unique pattern of response to oil price fluctuations between Malaysia and
Singapore and between the Philippines and Thailand. The pairs exhibit a
high degree of similarity in their responses; they do not share any common-
alities across the group.

Keywords: ASEAN-5; oil price; inflation; exchange rate; real GDP

JEL Classification: C32; E30; F41

I. Introduction disruption in oil supplies began. This led to a start

Oil has been a major source of energy since last
century. The importance of oil as a source of energy
has increased significantly after World War II, parti-
cularly with the increased use of automobiles as the
main source of transportation. Until the mid-1970s,
the international price of petroleum was more or less
stable. With the Iranian crisis in 1979, a major
in oil price rise, which continued until it peaked to
$106.36 (inflation adjusted) per barrel in 1980. With
the election of Reagan as the President of the United
States and the end of the Iranian hostage crisis, it
however started declining. The start of the oil price
decline began in 1981, which continued for several
years. This continued decline in the oil price can be
attributed to several factors. First, in the early 1980s,

*Corresponding author. E-mail: Kupadhyaya@newhaven.edu

3078 © 2015 Taylor & Francis

Impact of oil price shocks on output, inflation and the RER
most industrialized nations went through the eco-
nomic slowdown, which caused for a decrease in
demand for oil. Second, because of high oil price
for a long period businesses and firms adopted a
more energy-efficient operation. Third, during the
same time small Japanese cars became popular in
the US auto market as they were more fuel efficient
that resulted in replacing the gas guzzling big cars.
All these factors reduced the demand for oil signifi-
cantly, forcing the market to lower the price.
Additionally, during the same period the supply of
oil increased because of the finding of new oil
reserves such as North Sea in Europe. A combination
of decrease in demand and an increase in supply
dramatically reduced the world price of petroleum
all the way down to $17.10 (inflation adjusted) per
barrel in 1998.
The price of oil, however, started rising beginning
1999, which peaked in the summer of 2008. The
average price of crude oil reached $99.07 per barrel
(inflation adjusted) in 2008. There are several reasons
for this increase. First, in emerging economies the
use of modern modes of transportation such as auto-
mobiles is increasing, which increases the demand
for oil. Second, the increase in industrialization in the
emerging as well as developing countries has put
upward pressure on oil demand. Third, even in the
developing countries the use of modern modes of
transportation has increased significantly and at the
same time their primary economic sector, agriculture,
has become more mechanized, which also raises the
demand for oil. These are some of the important
factors that have helped increase oil price in recent
period. For the last several years, it has been hovering
around $100 per barrel, which is significantly higher
than the normal price level of around $20 per barrel
until the late 1990s.
A change in oil price affects different macroeco-
nomic variables in an economy. The transmission
mechanism through which the oil price impacts the
real economy includes both the demand and the
supply channels. The supply side effects are related
to the firm’s cost of production. For instance, an
increase in oil price raises production costs because
crude oil is used as a key intermediate input in the
production processes. This is more importantly true
in case of the goods made with petroleum products.
Oil price increase also raises the distribution costs of
the products of the firms via an increase in transpor-
tation cost. In addition, oil prices also indirectly
3079
affect the heating as well as manufacturing costs.
Increase in production costs can lead to a fall in
output and ultimately a decrease in aggregate supply
in the economy. The demand side effect stems from
consumption and investment. Fluctuations in oil
prices directly influence the consumption and expen-
diture patterns of households. Since the price elasti-
city of demand for oil is generally low, higher oil
prices may force the households to cut down on their
expenditures on other goods and services, which lead
to lower the demand for those goods and services. In
this regard, Sill (2007) suggests that higher oil prices
can reduce demand for other goods because they
reduce wealth and at the same time inducing uncer-
tainty about the future. Fernald and Trehan (2005)
argue that higher oil prices are like an increase in tax
on consumers because the extra payment that con-
sumers make to foreign oil producers can no longer
be spent on other kinds of consumption goods.
Bernanke (1983) notes that higher oil prices will
have an adverse effect on short-run economic perfor-
mance precisely because of their ability to disrupt
purchases of large ticket consumption and invest-
ment goods.
Another variable that oil price can affect is the
overall price level in the economy. As mentioned
above, oil is widely used as an input for production
as well as for distribution of the goods and services.
An increase in the price of oil, therefore, can increase
the production as well as the distribution cost of goods
and services. This eventually feeds into the price level
in the economy, leading to an increase in the inflation
rate. An increase in oil prices not only affects the
output and the prices in an economy, it also affects
the currency exchange rate of a country (see Cebula
and Michael Frewer, 1980; Hamilton, 1996; Amano
and Norden, 1998; Cebula, 2000; Issa et al., 2008). It
is well known that the standard theory of exchange
rate determination suggests that an increase in the
oil price causes the currency of an oil-exporting
country to appreciate as the demand for its currency
increases in the foreign exchange market. And con-
versely, an increase in oil price depreciates the cur-
rency of an oil-importing country because the
supply of its domestic currency in the foreign
exchange market increases.
There is a considerable amount of empirical litera-
ture that studies the effect of oil price shocks on
different macroeconomic variables (e.g. Hamilton,
1996, 2000; Hooker, 1996, 1999; Huntington,
3080
1998). In a seminal paper, Hamilton (1983) docu-
mented a significant systematic relationship between
oil prices and output in the US economy. He attrib-
uted oil price shocks to be the major contributing
factors in 9 out of 10 US recessions after World War
II. The similar findings to that of Hamilton (1983)
with respect to the impact of oil price shocks on
macroeconomic variables can also be found in
Cebula et al. (2002), Cunado and Garcia (2005),
Cologni and Manera (2008) and Kilian (2008). In a
study of eight developed countries, Backus and
Crucini (2000) show that a large part in the variabil-
ity of the terms of trade is associated with extreme
movements in oil prices. Their findings suggest that
the increased volatility in the terms of trade since the
Bretton Woods system seems largely due to the
increased fluctuations of oil price rather than the
volatility of nominal or real exchange rates (RERs).
Jiménez-Rodríguez and Sánchez (2005) assess the
effect of oil price shocks on real economic activity of
the major industrialized countries (a mix of oil
exporting and importing). Their findings report that
the real GDP growth of an oil-importing country is
negatively affected by any increases in oil price. With
regards to the oil-exporting countries, the effect,
however, appears to be ambiguous. Applying VAR
approach, Farzanega and Markwardt (2009) analyse
the dynamic relationship between oil price shocks
and major macroeconomic variables in the Iranian
economy (an oil-exporting country). They find a
positive relationship between oil price increases and
industrial output growth. But they also detected an
inflationary effect and an evidence of the Dutch
Disease because of the appreciation of the domestic
currency.
There are some studies that have investigated the
sources of macroeconomic fluctuations in the context
of purely oil-exporting countries and found that oil
price shocks are the main source of output fluctua-
tions (see Mehrara and Oskoui, 2007; El Anshasy
and Bradley, 2012). In contrast, Iwayemi and
Fowowe (2011) show that the effect of oil price
shocks on most of the Nigerian (an oil-exporting
country) macroeconomic variables is miniscule.
1
Park et al. (2011) classified 15 metropolitan cities and provinces of South Korea into 4 major regions (Capital, Central,
Honam and Gyeongsang) and analysed the effects of oil price fluctuations on the economy of these region. Their results
show that one region (Capital) is less affected by oil price fluctuations than the other three provincial regions.
Some studies examine the link between oil prices and stock market volatility among various countries (e.g. see Filis
et al., 2011; Arouri and Rault, 2012).
H. C. Basnet and K. P. Upadhyaya
Most of the studies mentioned above are either
based on the data from industrialized nations or
oil-exporting nations. There is a dearth of similar
studies in the context of ASEAN nations. One of
the studies related to ASEAN countries is by Chang
and Wong (2003). In their study of Singapore econ-
omy, they find an adverse impact of an oil price shock
on Singapore’s macroeconomic performance. But the
impact is marginal. Rafiq et al. (2009) examined the
impact of oil price volatility on key macroeconomic
variables in Thailand. Their empirical findings sug-
gest that, in most of the cases, oil price volatility has
an impact in the short run only and most notably on
investment and the unemployment rate. Another
study is by Ahmed and Wadud (2011) for Malaysia.
Their findings suggest an asymmetric effect of oil
price shocks on Malaysian industrial production and
inflation. Their variance decomposition analysis
reconfirms that volatility in the oil price is the second
most important factor to explain the variance of
industrial production after its own shocks.1 This find-
ing is consistent with Mehrara (2008), who report a
nonlinear and asymmetric relationship between oil
prices and economic growth of oil-exporting coun-
tries. Cunado and Garcia (2005) measured the impact
of oil price shocks on economic activity and CPIs for
six Asian countries and documented that the impact
was mainly limited to the short run.
The purpose of this study is to estimate and ana-
lyse the effect of oil price shock on output, inflation
and the exchange rates of the major ASEAN coun-
tries – Indonesia, Malaysia, the Philippines,
Singapore and Thailand (ASEAN-5) using quarterly
time series data from 1970 to 2010. ASEAN region is
one of the fastest growing regions in the world. It will
require a sustained increase in the energy supply to
maintain its growing economy. Even though the
ASEAN region controls almost 40% of the entire
oil and gas reserve of the Asia Pacific region,
Singapore, Thailand and the Philippines are still
highly dependent on oil imports (www.asean.org/
resources). On the other hand, Indonesia ranks as
one of the world’s top liquid natural gas (an alter-
native to oil) producers and Malaysia is leading the
Impact of oil price shocks on output, inflation and the RER
path of improving its energy technologies to enhance
energy efficiency. In 2010, each of these five coun-
tries recorded an economic growth of more than 6%.
This indicates that these countries have already
rebounded from the global economic crisis. In fact,
with economic recovery underway across the region
Singapore grew at a rate of 14% in 2010. According
to the OECD development centre’s 2010 Southeast
Asian Economic Outlook report, the average growth
rate of six ASEAN (including Viet Nam) is expected
to grow at a rate of 6% over the 2011–2015 period.
Given the spectacular economic growth of the region
in the recent years and its importance in the Asia
Pacific region, the purpose of this article is to esti-
mate and analyse the impact of oil price fluctuations
on different macroeconomic variables in Thailand,
Malaysia, Indonesia, Singapore and the Philippines.
Since the increase in oil price corresponds to negative
external shocks for oil-importing countries, this
study measures how sensitive are these emerging
countries to oil price fluctuations over time. It is
expected that this study will provide some important
policy implications for the academicians, business
community, as well as the policymakers.2
The rest of the article is organized as follows.
Section II provides the methodology and the data
used in this research. Section III presents the empiri-
cal results and discussion. Finally, in Section IV,
summary, conclusion and policy implications are
reported.
II. Methodology and Data
The primary purpose of this article is to estimate the
impact of oil price shocks on real GDP, the
exchange rate and the price level of the countries
under study. The theoretical link of oil price with
output, inflation and the RER was already discussed
in Section I. In order to estimate the effect of oil
price change (fluctuation) on these variables, we
develop a structural VAR (SVAR) model which
includes oil price (oilP) and three macroeconomic
variables – output (y), inflation (π) and the RER
(rEx). Before estimating the model, we conduct
2
While the entirety of the article may be taken as general policy prescriptions for emerging economies around the world,
given some unique characteristics (see on page 10) of the ASEAN countries, the findings of this article may not be
applicable to other countries or regions.
3081
Johansen’s (1988) cointegration test in order to
establish the long-run relationship between real
GDP, inflation and RERs, which allows us to iden-
tify the number of common trends among the vari-
ables. The SVAR model that we developed is as
follows:
A0 Xt ¼ A1 Xt1 þ . . . þ Ap Xtp þ εt (1)
where Xt represents an (n × 1) vector of relevant
variables as follows: Xt ¼ ½ΔoilPt ; Δyt ; Δπ t ; ΔrExt 0 ,
Ai represents 4 × 4 matrices of coefficients for i = 0,
1…P and εt is the vector of structural disturbances

y π rEx 0
denoted by εoilPt ; εt ; εt ; εt and they are assumed
to be independent and identically distributed (iid)
0
(i.e. Eðεt Þ ¼ 0 & Eðεt εt Þ ¼ ε Þ. The coefficient of
the structural equation in Equation 1 can be
obtained through the estimated reduced form:
A0 Xt ¼ A1 Xt1 þ . . . þ Ap Xtp þ εt
Xt ¼ A1 1 1
0 A1 Xt1 þ . . . þ A0 Ap Xtp þ A0 εt
Xt ¼ BðLÞXt þ μt
(2)
where BðLÞXt ¼ A01 A1 ðLÞ with A0 μt ¼ εt . The resi-
dual μt is the reduced form VAR and assumed to be
iid as well. A1 ðLÞ is a matrix of polynomial in the lag
operator (for detailed explanations of SVAR, see
Enders, 2004; Park et al., 2011).
Identification and contemporaneous restrictions
Since this study does not intend to test any particular
model, we base our identification restrictions on dif-
ferent economic theories and intuitions. We employ
only short-run restrictions on the contemporaneous
relations because the structural VAR based on short-
run restrictions perform well (Christiano et al.,
2007). The short-run restrictions primarily control
the contemporaneous feedback effects among the
variables in the model.
The identification in Equation 2 is obtained by
imposing restrictions on contemporaneous relation
among variables included in SVAR:
3082 H. C. Basnet and K. P. Upadhyaya
2 32 3 2 3
1 0 0 0 uoilP 1 0 0 0 Estimation of Equations 4–6 allows us to measure the
6a 7 6 7 6 07 influence of oil price shock on the macroeconomic
6 21 1 0 0 76 u y 7 6 0 1 0 7
6 76 7 ¼6 7 fundamentals of the ASEAN countries more
4 a31 a32 1 0 54 u π 5 4 0 0 1 05 precisely.
a41 a42 a43 1 urEx 0 0 0 1
2 3 Data
εoilP
6 ε 7 This article uses quarterly data from 1970Q1 to
6 y 7
6 7 2010Q2 for the ASEAN-5 countries. Variables that
4 επ 5
enter into the VAR model are oil price, real output,
εrEx inflation and RERs. For oil price, we use the spot
market price of West Texas Intermediate (WTI) crude
The identification restrictions are motivated by the oil, which is considered as the benchmark for world
following economic reasoning: first, since each of the oil prices. The WTI crude oil price is measured in US
ASEAN-5 countries are small open economies, they dollar and is obtained from the US Energy
are price takers in the oil market. And because the price Information Agency website. The required series on
of oil is determined by the global demand and supply output (real GDP), constant in 2000 US dollars, are
conditions, the domestic output level, inflation rates obtained from the World Bank’s World Development
and the exchange rates in any of our sample country Indicators, 2012. With respect to Inflation, the CPI is
will have a negligible effect on it. Therefore, the oil used to measure each country’s inflation rate. RER is
price is assumed to be exogenous. Thus, the reduced defined as the nominal exchange rate times the US
error term for oil price can be expressed as follows: CPI divided by the domestic price index (i.e. CPI).
The data for CPIs and the nominal exchange rates are
uoilP ¼ εoilP (3) derived from International Financial Statistics (CD-
ROM) provided by IMF. All variables are expressed
in natural logarithmic form.
Equation 3 shows that the error term of international
oil price will be equal to its structural error term.
However, in case of other variables in our model, a
change in oil price can have a contemporaneous effect III. Empirical Results and Discussion
on them as an increase (decrease) in oil price can raise
(reduce) the cost of production because oil is used as Unit root and cointegration tests
one of the important inputs in the production as well as Macroeconomic time series data are usually nonsta-
the distribution of goods and services. Second, we tionary, and the use of nonstationary data produces
assume that the output does not respond contempor- spurious results (Nelson and Plosser, 1982). In order
aneously to any changes in the domestic variables to ensure the stationarity of the data series, ADF and
(second row in the identification matrix). Third, the Phillips–Perron test (1988) are conducted. The test
domestic price level is assumed to be influenced by all results are reported in Table 1. As seen in the table, all
the variables except the exchange rate. Finally, we do the data series are found nonstationary in the level.
not impose any restrictions with respect to exchange The CPI of Malaysia and Singapore, although
rate, suggesting that the exchange rate responds to appears stationary in the ADF and the Phillips–
changes in all variables. The reduced form error Perron tests, however, indicate that they are nonsta-
terms of the domestic variables (real GDP, inflation tionary. Since the Phillips–Perron tests are known to
and the RER) are as follows: be more robust than the ADF tests (Brooks, 2008),
we proceed with the analysis under the assumption
uy ¼ a21 uoilP þ εy (4) that oil prices are nonstationary in levels. After estab-
lishing the stationarity properties of the data, we
proceed with the examination of common trends
uπ ¼ a31 uoilP  a32 uy þ επ (5) among the variables using an unrestricted cointegra-
tion test. The lag-lengths of the unrestricted cointe-
urEx ¼ a41 uoilP  a42 uy  a43 þ εrEx (6) gration systems are determined by minimizing the
Impact of oil price shocks on output, inflation and the RER 3083
Table 1. Unit root tests 5 and 3 lags, respectively. The cointegration test
results are reported in Table 2.
ADF PP
As reported in Table 2, the null hypothesis of no
First First cointegration is rejected at 5% critical level and both
Variables Levels difference Levels difference the λ  trace and the λ  max statistics indicate the
IDN presence of two cointegrating vectors, that is, r = 2.
rgdp −1.57 −2.90** −2.01 −5.59* This implies that there is a presence of n  r ¼ 5 
CPI −1.51 −7.21* −1.33 −7.23* 2 ¼ 3 common trends between the real GDP of the
rEx −1.46 −11.12* −0.73 −11.10* ASEAN-5 countries. The cointegration test results
MYS also indicate the existence of 2 and 1 cointegrating
rgdp −1.47 −3.21* −1.61 −5.89*
CPI −2.92** −5.36* −2.66 −7.88* vectors for CPI and the RERs, respectively, implying
rEx −1.41 −11.05* −1.49 −11.04* 3 and 4 common trends between the CPI and the
PHL RERs, respectively, in ASEAN-5. These results
rgdp 0.02 −2.78*** −0.59 −4.23* further suggest that these macroeconomic variables
CPI −2.65 −5.46* −3.31* −7.07* of the ASEAN-5 cannot swing independently for a
rEx −1.31 −7.12* −1.30 −13.80*
SGP long time; they eventually move together in the long
rgdp −1.24 −3.70* −2.15 −5.49* run. We know that the existence of cointegrating
CPI −4.88* −3.97* −2.90** −5.93* relationship does not imply that these countries do
rEx −1.97 −11.27* −2.03 −11.49* not have policy differences; it simply means that the
THA short-run deviation will be corrected by internal
rgdp −1.51 −2.74*** −1.68 −4.78*
CPI −2.80 −6.15* −2.75 −6.28* dynamics within the system that corrects misalign-
rEx −1.21 −12.06* −1.21 −12.08* ment and brings these economies back to the equili-
OilP −1.97 −10.34* −1.78 −10.14* brium path in the long run (Darrat and Al-
Notes: *, ** and *** indicate significant at 1, 5 and 10%
Shamsi, 2005).
level, respectively.
IDN, Indonesia; MYS, Malaysia; PHL, Philippines; SGP, Impulse response
Singapore; THA, Thailand. In order to analyse the effect of oil price shocks, we
conducted the impulse response test of a onetime oil
AIC starting with a maximum lag-length of eight price shock on real GDP, inflation and the RERs.
lags. The AIC criteria indicate that the appropriate The impulse response test results are reported in
lag-lengths for real GDPs, inflations and RERs are 6, Fig. 1 (a–c) through Fig. 5 (a–c). Each figure traces

Table 2. Cointegration test results

Critical values (5%)
Variables Eigenvalues Null hypothesis λ-trace λ-max λ-trace λ-max
rgdp 0.287 r=0 110.98 53.26 76.97 34.80
0.183 r≤1 57.71 31.92 54.07 28.58
0.087 r≤2 25.79 14.44 35.19 22.29
0.042 r≤3 11.34 6.79 20.26 15.89
0.028 r≤4 4.55 4.55 9.16 9.16
CPI 0.257 r=0 97.46 46.48 76.97 34.80
0.141 r≤1 50.98 23.70 54.07 28.58
0.077 r≤2 27.27 12.57 35.19 22.29
0.061 r≤3 14.70 9.77 20.26 15.89
0.031 r≤4 4.93 4.93 9.16 9.16
rEx 0.213 r=0 78.04 37.63 60.06 30.43
0.108 r≤1 40.40 18.02 40.17 24.15
0.095 r≤2 22.38 15.81 24.27 17.79
0.029 r≤3 6.56 4.63 12.32 11.22
0.012 r≤4 1.93 1.93 4.12 4.12
Note: rgdp = real GDP and rEx = Real exchange rate.
3084 H. C. Basnet and K. P. Upadhyaya

(a) the horizontal line, the response becomes statisti-

.0020 cally insignificant.
Figure 1 (a–c) displays the response of the
.0015
Indonesian output, inflation and the RER, respec-
.0010 tively, to 1 SD structural innovation in oil price.
The Indonesian output shows a statistically positive
.0005
response to innovations for up to the first four quar-
.0000 ters (Fig. 1a). After the fourth quarter, the economy
begins to experience a contractionary effect. This
–.0005
negative impact, however, dies out after nine quar-
–.0010 ters, leading to again an expansionary phase in the
1 2 3 4 5 6 7 8 9 10 longer horizon. The effects of positive oil price
(b) shocks are different for oil-importing and oil-
.004 exporting countries. Oil-exporting countries may
.003 experience a positive impact on the economy at
.002 least in the short run. The positive impact may fade
away over time due to, among others, higher wage
.001
demands, which feed into the cost of production and
.000
consumer prices. Among the ASEAN-5, Indonesia is
–.001 an oil-exporting country and hence the country
–.002 experiencing an expansionary effect due to a positive
–.003 oil price shock is consistent with the conventional
–.004 wisdom. As expected, a positive oil price shock leads
1 2 3 4 5 6 7 8 9 10 to an inflationary effect contemporaneously (Fig.1b).
(c) It is also observed that the price level tends to
.015 decrease quickly after the first quarter, followed by
a sustained rise. The response is statistically signifi-
.010
cant for all the 10 quarters of time horizon. Our
.005 finding concurs with the evidence found by
Mehrara and Oskoui (2007), where oil price shocks
.000 have a very small effect on Indonesian output.
–.005 The contemporaneous effect of oil price shock on
the RER depicts a decline on it. It, however, starts
–.010 rising beginning the next quarter. The response of the
–.015
RER is more volatile than output and inflation as is
1 2 3 4 5 6 7 8 9 10 seen in Fig. 1(c). In the long run, Indonesian currency
suffers from depreciation. The impulse responses of
Fig. 1. Impulse response graphs. (a) Response all macroeconomic variables are statistically signifi-
of IDN_Real GDP to Shock1. (b) Response of IDN_
Inflation to Shock1. (c) Response of IDN_Exchange cant, suggesting that the Indonesian economy seems
rate to Shock1. Shock1 = oil price shock to have adverse impacts in its real and financial
sectors due to oil price shocks.
The impulse responses of Malaysia, Singapore, the
the effect of onetime positive shock to the oil price Philippines and Thailand display a very interesting
on the present and future course of each of the economic interdependency (see Figs 2–5). The
variables under consideration. The confidence results indicate that these four countries can be paired
bands are reported at the 95% confidence level. into two groups in terms of their similarity in
The solid line in the figures represents the actual responses. Malaysia and Singapore constitute the
impulse response. The dotted lines represent the first pair with the homogenous response to the oil
confidence intervals (upper and lower bands). If price shocks, while the Philippines and Thailand
the upper and lower bands coincide with or cross make another pair with identical responses. Note
Impact of oil price shocks on output, inflation and the RER 3085

(a) (a)
.00150 .0020
.00125
.0015
.00100

.00075
.0010
.00050

.00025 .0005

.00000
.0000
–.00025

–.00050 –.0005
1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
(b) (b)
.00150 .0020
.00125
.0015
.00100

.00075 .0010

.00050
.0005
.00025
.0000
.00000

–.00025 –.0005
–.00050
1 2 3 4 5 6 7 8 9 10 –.0010
1 2 3 4 5 6 7 8 9 10
(c)
.004
(c)
.004

.002
.002

.000
.000

–.002
–.002

–.004
–.004

–.006
1 2 3 4 5 6 7 8 9 10 –.006
1 2 3 4 5 6 7 8 9 10
Fig. 2. Impulse response graphs. (a) Response
of MYS_Real GDP to Shock1. (b) Response of Fig. 3. Impulse response graphs. (a) Response
MYS_Inflation to Shock1. (c) Response of MYS_ of SGP_Real GDP to Shock1. (b) Response of
Exchange rate to Shock1. Shock1 = oil price shock SGP_Inflation to Shock1. (c) Response of SGP_
Exchange rate to Shock1. Shock1 = oil price shock

that the responses across the group are somewhat
asymmetrical. This study intends to interpret the
findings in the spirit of response similarities between
these two groups.
Figures 2 (a–c) and 3 (a–c) display the impulse
response of Malaysian and Singaporean macro-
variables. It is observed that the immediate response
of real output to a onetime positive shock to oil price
is positive. The growth of output, however, begins to
slow down right after the first quarter and dies out in
the fifth quarters. The possible reason for experien-
cing a brief positive effect could be companies may
embed the oil price hike in their sale prices before it
passes on to the cost of production. This action will
boost up industrial production. The effects are statis-
tically significant up until the sixth quarters. The
3086 H. C. Basnet and K. P. Upadhyaya

(a) (a)
.0008 .0008

.0006
.0004
.0004

.0002 .0000
.0000

–.0002 –.0004

–.0004
–.0008
–.0006

–.0008 –.0012
1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
(b) (b)
.004 .004

.003 .003

.002 .002

.001 .001

.000 .000

–.001 –.001
1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
(c) (c)
.004 .004

.003 .003

.002 .002

.001 .001

.000 .000

–.001 –.001

–.002 –.002

–.003 –.003

–.004 –.004
1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

Fig. 4. Impulse response graphs. (a) Response Fig. 5. Impulse response graphs. (a) Response
of PHL_Real GDP to Shock1. (b) Response of of THI_Real GDP to Shock1. (b) Response of
PHL_Inflation to Shock1. (c) Response of PHL_ THI_Inflation to Shock1. (c) Response of THI_
Exchange rate to Shock1. Shock1 = oil price shock Exchange rate to Shock1. Shock1 = oil price shock

reaction of inflation to the shock in oil price in both
countries is very similar and positive. As oil-
importing countries, as expected, the price level
shoots up contemporaneously (Figs 2b and 3b).
Prices begin to show a lesser impact as time passes,
which suggests that the oil price hike slowly assim-
ilates into the prices of other goods and services until
the new equilibrium is achieved. Contrary to the
price level, as a result of oil price shock, the RERs
of both countries fall but its effect becomes insignif-
icant after the fifth quarter. The findings from
Malaysia and Singapore indicate that the oil price
shock is not significant in affecting any of the macro-
economic variables under study in the longer hori-
zon. Dynamic responses of Malaysia and Singapore
to oil price shock in this study differ from the past
Impact of oil price shocks on output, inflation and the RER
studies. For instance, Ahmed and Wadud (2011), in a
single-country (i.e. Malaysia) analysis, document
that oil price uncertainty caused a significant decline
in Malaysian aggregate output. Likewise, in case of
Singapore, Chang and Wong (2003) also find an
adverse impact of an oil price shock on Singapore’s
macroeconomic performance.
Unlike the case of Malaysia and Singapore, a
positive oil price shock has a contractionary effect
on the output of the Philippines and Thailand (Figs 4a
and 5a). This effect is rather brief and is completed in
the first quarter showing a positive effect momenta-
rily. Afterwards the shock generates a contractionary
impact, which is statistically significant throughout
the 10 quarters horizon. While this effect becomes
trivial in the longer horizon, a significant negative
effect is observed for a prolonged period. Figures 4
(b) and 5(b) suggest that a positive oil price shock has
an inflationary impact in both the Philippines and
Thailand’s economy but the effect begins to subside
right after the first quarter. While inflation in
Thailand witnesses a sharp drop right after the first
quarter (Fig. 5b), there is a sustained negative reac-
tion in the Philippines (Fig. 4b). The significant effect
dissipates in both countries in the longer horizon. Our
findings echo the findings of Rafiq et al. (2009), that
is, no significant impact of oil price volatility in the
Thai economy in the longer horizon. Further to the
point, Cunado and Garcia (2005) find evidence that
the impact of oil shocks on macroeconomy of Asian
countries is limited to the short term. It is fair to say
that oil-importing countries are found to have a nega-
tive impact of oil price hike on economic activities.
The ASEAN countries are oil-importing countries
and a negative impact, only in the short run though,
is consistent with the conventional wisdom. In a
study of some of the OECD oil-importing countries,
Jiménez-Rodríguez and Sánchez (2005) also find a
negative effect of oil shocks on economic activity in
all cases (individual G-7 countries, Norway and the
Euro area as a whole) except in Japan. As explained
before, the higher oil price is transmitted into the
prices of goods and services, leading to a new equili-
brium in the longer horizon. The RER (Fig. 5c)
seems to be unaffected contemporaneously in
Thailand, rises temporarily after the third quarter,
reaches to its peak around the fourth quarter, after
which the impact is no longer significant. Almost an
identical phenomenon can be observed in the
Philippines (see Fig. 4c). These findings suggest
3087
that the countries in each group tend to respond to
the oil price shocks symmetrically. Further, a careful
observation of the figures indicates that the effect of
an oil price shock on inflation is quite similar in all
four countries (except Indonesia) during the entire 10
quarters horizon. One possible reason of such sym-
metric response of inflation could be that these
AEAN countries were successful in keeping the
inflation rates within 5–6% range beginning the
early 1990s by adopting several adjustment pro-
grammes in their policies (Upadhyaya and
Upadhyay, 1999). Indonesia, however, still suffered
from close to the double-digit inflation during the
1990s and 2000s; it recorded an almost 21% inflation
during the Asian financial crisis.
The similar responses between these two groups –
Malaysia–Singapore, and the Philippines–Thailand,
warrant further economic intuitions. First, presum-
ably the economies of Malaysia and Singapore are
more integrated with each other relative to other
countries in the ASEAN-5. Second, these two econo-
mies are driven by manufacturing, financial and ser-
vice sectors. Third, these two economies have a well-
developed capital market, have attracted large scale
of FDI and have successfully implemented financial
and economic reforms leading to macroeconomic
stability. On the other hand, the economies of the
Philippines and Thailand largely consist of agricul-
tural sectors and they have histories of financial dis-
tress and crises. With relatively less stable and less
investment-friendly financial and economic system,
the two countries, unlike the former group, have not
been able to secure the same level of foreign invest-
ment. Above all, Indonesia stands distinctly out.
Among the ASEAN-5, Indonesia lacks sound eco-
nomic fundamentals. It suffered several banking,
financial and political crises during this study period.
Indonesian currency experienced the most severe
devaluations during and before the Asian crisis, just
to provide an example. The differences in macroeco-
nomic fundamentals among these countries corrobo-
rate the findings of our article. Countries may
experience a differential impact of oil price shocks
due to some variables such as their sectoral composi-
tion or their relative position as oil importer or expor-
ter (Cunado and Garcia, 2005). Therefore, the similar
response between Malaysia and Singapore and
between the Philippines and Thailand and the stan-
dalone response of Indonesia can be explained in
light of these contrasts.
3088 H. C. Basnet and K. P. Upadhyaya
Variance decompositions almost the same forecast error variation (see Table 3)
for each group mentioned in the previous section.
The variance decompositions (VDCs) of real out-
The estimated results indicate that oil price explains
puts, inflations and the RERs in the ASEAN-5 coun-
approximately the same variations in the macroeco-
tries because of oil price shock are reported in
nomic variables throughout the 10 quarters in
Table 3. This study intends to focus on the influence
Indonesia, Malaysian and Singapore. The results
of oil price shock on the real output, inflation and
show that oil price innovations explain almost 3
RER. Therefore, we limit our discussion of the fore-
and 5% forecast error in every quarter of the 10
cast error variances explained by oil price only. The
quarters in the real GDP of Malaysia and
VDC results largely confirm the findings from
Singapore, respectively. With respect to inflation
impulse response, that is, with a few exceptions, oil
and RERs, approximately the same variation can be
price shock has a much weaker influence on the
explained by uncertainty in the oil price during the 10
ASEAN economies. Interesting enough, the empiri-
quarters horizon. It accounts for 5.52 and 4.06%
cal results suggest that the oil price shock explains
variations in the inflation rate in Malaysia and
Singapore, respectively, in the tenth quarter. Almost
Table 3. VDCs of domestic variables due to oil price 5% of variance in the RER in Singapore is explained
shock by oil price shocks, whereas it explains only about
Real GDP Inflation Exchange rate 3% of the fluctuations in the RER in Indonesia. Oil
price contributes about the same variations in the
Period Indonesia Indonesian economy as in Malaysian and Singapore.
1 2.93 3.18 2.48
2 3.62 2.66 2.96
In the case of the Philippines and Thailand, the oil
4 4.62 2.46 3.01 price explains approximately the same level of fore-
6 4.68 2.36 3.50 cast error variation in real output and exchange rates
8 4.84 3.03 3.64 in both countries. It contributes very minimum varia-
10 4.82 3.22 3.74 tions (1.7 and 0.5% at most during the 10 quarters
Period Malaysia horizon for the Philippines and Thailand, respec-
1 3.11 4.15 2.12 tively) to the real GDP. Similarly, it does not exert a
2 3.87 5.78 3.21
4 3.29 5.52 3.26
significant impact in RER fluctuations. It explains
6 3.18 5.55 3.27 less than 1% of variation in the RER of these two
8 3.17 5.53 3.27 countries. This suggests that RER fluctuations in the
10 3.17 5.52 3.27 ASEAN-5 countries are not mostly due to oil price
Period Singapore shocks. But oil price shocks explain relatively a sig-
1 5.77 4.95 4.41 nificant portion of forecast errors in the inflation in
2 7.07 5.33 4.31 Thailand. It induces more than 21% variation in the
4 5.81 4.22 4.64
6 5.48 4.11 4.68
second quarters, which drops to 17.84% in the sixth
8 5.36 4.06 4.68 quarters and 17.42% in the tenth quarters, indicating
10 5.32 4.04 4.68 a persistent impact during the entire time horizon.
Period Philippines Like in Thailand, oil price shocks contribute a sig-
1 1.59 5.61 0.092 nificant fluctuation to the inflation in the Philippines.
2 1.34 6.54 0.092 It explains 6.54% of variation in the second quarters,
4 1.26 7.31 0.163 which increases to 7.61% in the sixth quarters and
6 1.51 7.61 0.163
8 1.68 7.71 0.164
7.73 in the tenth quarters. However, in Indonesia,
10 1.77 7.73 0.165 Malaysia and Singapore, it hovers around 3, 5 and
Period Thailand 4%, respectively, during the 10 quarters of the
1 0.031 20.96 0.173 horizon.
2 0.081 21.15 0.219 The impulse response and the VDC results suggest
4 0.343 18.45 0.433 that the oil price shocks do not have a major impact
6 0.462 17.84 0.446 on output, inflation and exchange rate in the
8 0.492 17.55 0.446
10 0.504 17.42 0.446
ASEAN-5 in the long run. Given that these econo-
mies are fairly open and very competitive in export, it
Impact of oil price shocks on output, inflation and the RER
is possible that any negative effect of oil price
increase in exchange rate, inflation and output is
neutralized by their export demand. In addition,
these countries are the favourite destination of
resource-seeking as well as market-seeking FDIs,
which also could have helped to dampen the negative
effect of oil price on their macroeconomic variables.
Further to this point, the significant presence of FDI
in these economies can be related to the asymmetric
effect of oil price shocks. For example, when there
are large oil price shocks, the foreign companies may
find technologies that use alternate energy such as
gas or coal, rather than cutting production.
Equivalently, when oil price declines, the multina-
tional companies do not give up their investment on
alternative technologies to minimize sunk costs.
With respect to the impact of oil price shocks, our
findings are in accordance with the findings of
Cunado and Garcia (2005), who suggest that the
impact of oil price shock is limited to the short run
for Asian countries that include four of the five
sample countries in this study.
IV. Conclusion and Policy Implication
This study empirically examines the impact of oil
price shock on key macroeconomic variables of the
ASEAN-5 by using SVAR analysis. The cointegra-
tion tests show that the macroeconomic variables of
these countries are cointegrated, suggesting that they
share a common trend in the long run. Our findings
suggest that an oil price shock is not the major
impediment of economic growth in ASEAN-5 coun-
tries as the impulse response function indicates that
oil price volatility does not impact in the long run,
much of its effect is absorbed within 5–6 quarters.
The VDC results also reveal that oil price volatility
does not explain any significant portion of forecast
errors of any of the macroeconomic variables, with
exception to the inflation rate in Thailand. Based on
overall findings, we conclude that the oil price shock
does not induce much of the fluctuations in the
ASEAN-5 economies; and the impact is a short-
term one. One of the interesting findings of this
study is that while Indonesia does not exhibit any
similarities in responding to oil price shocks with
Thailand, Malaysia, Singapore and the Philippines,
the latter four can be paired into two groups with
respect to their responses to oil price shocks.
3089
Malaysia and Singapore display identical responses
contemporaneously as well as in the longer horizon.
The same holds true for the Philippines and Thailand.
But the response across these two groups is different.
We attribute this finding to the similarities as well as
dissimilarities to their macroeconomic fundamentals.
However, while sectoral compositions are very much
alike between the two groups, more research in future
is needed to further confirm such pairwise sym-
metric/asymmetric responses.
The findings of this study provide a number of
policy implications for the ASEAN-5 countries.
First, while macro-variables under consideration did
not show any significant changes following oil price
shocks in the longer horizon, each of the five coun-
tries should put a defensive mechanism in place to
prevent the immediate negative impact. Second, our
findings suggest that oil price shocks do not have any
significant effect on the macroeconomic perfor-
mances of these countries presumably because of
the large inflow of FDI as well as the thriving export
sectors. Therefore, the ASEAN countries should
implement policies that attract more FDI as well as
promote the foreign sector of the economy. Third,
since our estimation indicates that Thailand is more
prone to higher inflation rate because of the oil price,
the Thai government should be more vigilant in con-
trolling the price level that may increase with the
increase in the oil price. Finally, a policy coordina-
tion, not only the macroeconomic but also regulatory,
as well as social policy might be more helpful to deal
with the external shocks, including the oil price
shocks.
Disclosure Statement
No potential conflict of interest was reported by the
authors.
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