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Satu sampel bulanan 1980-2005 dari Malaysia dikajikan sama ada tindak balas output, kadar pertukaran dan tingkat harga t

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− UNIVERSITI MALAYSIA SABAH BORANG PENGESAHAN STATUS TESIS a JUDUL: DOMESTIC MACROECONOMIC ADJUSTMENT TO OIL PRICE SHOCKS UNDER DIFFERENT EXCHANGE RATE REGIMES IN MALAYSIA. DAZAH: SARJANA EKONOMI (EKONOMI KEWANGAN) SESI PENGAJIAN: 2005-2007 Saya, CHONG HUI ING mengaku membenarkan tesis Sarjana ini disimpan di Perpustakaan Universiti Malaysia Sabah dengan syarat-syarat kegunaan seperti berikut: 1. Tesis adalah hakmilik Universiti Malaysia Sabah. 2. Perpustakaan Universiti Malaysia Sabah dibenarkan membuat salinan untuk tujuan pengajian saya. 3. Perpustakaan dibenarkan membuat salinan tesis ini sebagai bahan pertukaran antara institusi pengajian tinggi. 4. TIDAK TERHAD. Disahkan oleh (Penulis: CHONG HUI ING) (TANDATANGAN PUSTAKAWAN) Alamat: Peti surat 1249, 91037 Tawau, Sabah. (Penyelia: Dr. Fumitaka Furuoka) Tarikh: 15 August 2007 Tarikh: - - - - Catatan: a Tesis dimaksudkan sebagai tesis Ijazah Doktor Falsafah dan Sarjana secara penyelidikan atau disertassi bagi pengajian secara penyelidikan, atau laporan Projek Sarjana Muda (LPSM). kerja kursus dan DOMESTIC MACROECONOMIC ADJUSTME.NT TO OIL PRICE SHOCKS UNDER DIFFERENT EXCHANGE RATE REGIMES . IN MALAYSIA. CHONG HUI ING PERPJSTAKAA ..J UNIVERSITI MALAYS1.1\ SI\BAH A THESIS IS SUBMIlTED IN THE FULFILLMENT OF REQUIREMENT FOR THE DEGREE OF MASTER OF ECONOMICS SCHOOL OF BUSINESS AND ECONOMICS UNIVERSITI MALAYSIA SABAH 2007 DECLARATION The materials in this thesis are original except for quotations, excerpts, summaries and references, which have been duly acknowledged. (~O~j CHONG HUI ING PS05-002-073 15 AUGUST 2007 ACKNOWLEDGEMENT I would like to express my appreciation to my supervisors, Dr. Fumitaka Furuoka and Dr. Wong Hock Tsen, who have made valuable comments and suggestions to improve the thesis substantially. lowe the debt to Madam Sharija Che Shaari for her helps at different stages of the thesis. I would also like to thank the staffs in Perpustakaan Universiti Malaysia Sabah for their helps in collecting information. As always, I am grateful to my family for their support. ii ABSTRACT This thesis examines on the insulation properties of flexible exchange rate regime against fixed exchange rate regime from oil price shocks. A monthly sample 19802005 from Malaysia is investigated whether the response of output, exchange rate and price level to oil price shocks are different across exchange rate regimes in the short run by applying Structural Vector Autoregressive model. The oil prices are found to be exogenous to the macroeconomic variables in Malaysia. Results show that the short run output responses to oil price disturbances are smoother under flexible exchange regime than fixed exchange regime. And there is asymmetric response of domestic variables to positive and negative oil price shocks across and within exchange regimes. iii ABSTRAK PENYESUAIAN MAKROEKONOMI DOMESTIK TERHADAP KEJUTAN HARGA MINYAK DI BAWAH SESTEM KADAR PERTUKARAN YANG BERLAINAN DI MALA YSIA. Tesis ini mengkaji ciri-ciri penyingkiran sistem kadar pertukaran boleh ubah berbanding dengan sistem kadar pertukaran tetap daripada kejutan harga minyak. Satu sampel bulanan 1980-2005 dari Malaysia dikajikan sama ada tindak balas output, kadar pertukaran dan tingkat harga terhadap kejutan harga minyak adalah berlainan di bawah sistem kadar pertukaran yang berbeza dengan mengaplikasikan model ''Structural Vector Autoregressive'~ Harga minyak didapati eksogen kepada pembolehubah makroekonomi di Malaysia. Keputusan menunjukkan bahawa tindak balas jangka pendek output terhadap kejutan harga minyak adalah lebih licin di bawah sistem pertukaran boleh ubah daripada sistem pertukaran tetap. Ttndak balas asimetri pembolehubah domestik terhadap kejutan harga minyak positif dan negatif wujud antara dan dalam sistem pertukaran. iv LIST OF ABBREVIATIONS ADF AIC CFA CFA CPI EIA EMS GARCH GDP GNP IFS IMF Ml M2 NYMEX OECD OLS PPI UNCTAD VAR VARY.. VECM WIT Augmented Dickey-Fuller Akaike Information Criteria Cooperation financiere en Afrique centrale (for Central Africa) Communaute financiere d'Afrique (for West Africa) Consumer Price Index Energy Information Administration European Monetary System Generalized Autoregressive Conditional Heteroskedasticity Gross Domestic Product Gross National Product International Financial Statistics International Monetary Fund Monetary Aggregate 1 Monetary Aggregate 2 New York Mercantile Exchange Organization of Economic Co-operation and Development Ordinary Least Square Producer Price Index United Nations Conference on Trade and Development Vector Autoregressive Vector Autoregressive with Exogenous Variables Vector Error Correction Model West Texas Intermediate v LIST OF CONTENTS PAGES DECLARATION ACKNOWLEDGEMENT ii ABSTRACT iii ABSTRAK iv LIST OF ABBREVIATIONS v LIST OF CONTENTS vi LIST OF FIGURES viii LIST OF TABLES ix GLOSSARY x KEYWORDS xi CHAPTER 1: INTRODUCTION 1.1 1.2 1.3 1.4 1.5 1.6 1.7 INTRODUCTION STATEMENT OF PROBLEM RESEARCH QUESTIONS OBJECTIVES OF STUDY SIGNIFICANCE OF STUDY SCOPE OF STUDY ORGANIZATION OF STUDY CHAPTER 2: BACKGROUND OF STUDY 2.1 2.2 2.3 INTRODUCTION MALAYSIA AS A PRICE TAKER OF CRUDE OIL IMPACT OF CHANGES OF OIL PRICES ON MALAYSIA 2.3.1 CHANGES OF OIL PRICES AND INFLATION RATE 2.3.2 CHANGES OF OIL PRICES AND OUTPUT GROWTH 2.4 RESPONSES OF ECONOMIC POUCIES TO THE INCREASE OF OIL PRICES 2.5 DEVELOPMENT OF EXCHANGE RATE REGIMES IN MALAYSIA 2.6 SUMMARY CHAPTER 3: LITERATURE REVIEW 3.1 3.2 3.3 INTRODUC110N THE FRIEDMAN'S (1953) HYPOTHESIS RESULTS OF RELATED PAST STUDIES 3.3.1 THE OIL PRICES AND MACROECONOMIC VARIABLES 3.3.2 THE ROLE OF EXCHANGE RATES IN INSULATING THE EXTERNAL SHOCKS 3.3.3 PAST STUDIES IN THE CASE OF MALAYSIA 3.4 SUMMARY CHAPTER 4: METHODOLOGY 4.1 INTRODUCTION 1 1 4 4 5 5 6 7 8 8 8 9 11 11 14 17 19 20 20 20 21 21 28 36 39 40 40 vi PAGES 4.2 4.3 4.4 4.5 UNIT ROOT TEST JOHANSEN COINTEGRATION TEST THE EXOGENEIlY OF OIL PRICES VAR MODEL 4.5.1 STRUCTURAL VAR MODEL 4.5.2 THE IDENTIFICATION ISSUE 4.5.3 IDENTIFICATION OF STRUCTURAL VAR MODEL 4.5.4 ESTIMATING STRUCTURAL VAR MODEL 4.5.5 ESTIMATING IMPULSE RESPONSE FUNCTION 4.5.6 ESTIMATING VARIANCE DECOMPosmON 4.6 DEFINmONS OF DATA 4.7 SOURCES OF DATA 4.8 SUMMARY CHAPTER 5: RESULTS 5.1 5.2 5.3 5.4 5.5 5.6 5.7 5.8 5.9 INTRODUCTION UNIT ROOT TESTS JOHANSEN COINTEGRATION TESTS THE EXOGENEIlY OF OIL PRICES IMPULSE RESPONSES TO OIL PRICE SHOCKS ASYMMETRIC EFFECTS UNDER DIFFERENT REGIMES RELATIVE IMPORTANCE OF OIL PRICE SHOCKS ALTERNATIVE EVIDENCE ON OIL PRICE SHOCKS SUMMARY CHAPTER 6: CONCLUSION 6.1 6.2 6.3 6.4 6.5 6.6 6.7 REFERENCES APPENDIX A: APPENDIX B: APPENDIX C: APPENDIX D: INTRODUCTION FINDINGS OF STUDY DISCUSSION IMPLICATIONS OF STUDY LIMITATIONS OF STUDY SUGGESTIONS FOR FUTURE STUDY CONCLUSION 40 41 42 43 44 46 48 49 50 50 51 52 53 54 54 54 56 57 57 60 63 66 72 73 73 73 75 77 80 81 82 84 RECOVERING STRUCTURAL VAR MODEL IDENTIFICATION BY BLANCHARD AND QUAH (1989) DATA USED AND RELATED GRAPHS OUTPUT OF EVIEWS 89 91 92 100 vii LIST OF FIGURES PAGES Figure 1.1 Trade and Share of Trade to GDP 2 Rgure 1.2 FDI and Share of FDI to GDP 3 Figure 2.1 Malaysia Production, Consumption, Exports and Imports of Crude Oil 9 Figure 2.2 Prices of Crude Oil and Petroleum Products 10 Figure 2.3 Malaysia Producer Price Index and Consumer Price Index 10 Figure 2.4 Fluctuations of World Crude Oil Prices and Malaysia Output 13 Figure 2.5 Changes of Malaysia Revenue, Subsidies and Sales Taxes of Oil 15 Figure 2.6 De Facto Exchange Rate Analysis 18 Figure 5.1 Responses to Oil Price Shocks 58 Figure 5.2 Flexible Period: Responses to Positive and Negative Oil Price Shocks 61 Figure 5.3 Fixed Period: Responses to Positive and Negative Oil Price Shocks 62 Rgure 5.4 Responses to Oil Price Shocks 68 Figure 5.5 Flexible Period: Responses to Positive and Negative Oil Pri~e Shocks 69 Figure 5.6 Fixed Period: Responses to Positive and Negative Oil Price Shocks 70 Figure C.1 Changes of Real Oil Prices 99 viii LIST OF TABLES PAGES Table 2.1 Malaysia Production and Exports of Crude Oil Table 2.2 Changes of Producer Price Indicator and Consumer Price Indicator 12 Table 2.3 Overnight Policy Rate 16 Table 2.4 De Jure Exchange Rate Analysis 16 Table 5.1 Unit Root Tests 55 Table 5.2 Johansen Cointegration Tests 56 Table 5.3 F - statistics of Granger Causality Tests 57 Table 5.4 Variance Decompositions of Domestic Variables 64 Table 5.5 Unit Root Tests 66 Table 5.6 Johansen Cointegration Tests 67 Table 5.7 F - statistics of Granger Causality Tests 67 Table 5.8 Variance Decompositions of Domestic Variables 71 Table 6.1 Exports of Crude Oil by Major Countries (Percent) 78 Table 6.2 Imports of Crude Oil by Major Countries (Percent) 79 Table C.l Data from January 1980 to June 2005 92 Table 0.1 Johansen COintegration Test of oil, y, rer, p 100 Table 0.2 Johansen Cointegration Test of oil, y, reer, p 103 Table 0 .3 F - statistics of Granger Causality Test of oil, y, rer, p 106 Table 0.4 F - statistics of Granger Causality Test of oil, y, reer, p 108 Table 0.5 Flexible: Variance Decompositions of oil, y ., rer, p 110 Table 0.6 Fixed: Variance Decompositions of oil, y, rer, p 113 Table 0.7 Flexible: Variance Decompositions of oil, y, reer, p 116 Table 0.8 Fixed: Variance Decompositions of oil, y, reer, p 119 9 ix GLOSSARY Endogenous Variables with values determined inside the model. Exogenous Variables with value that is not explained within the model. Fixed rate regime A system in which a country maintains a fixed value of its currency in terms of other currencies. Flexible rate regime Rates that are completely free to vary; that is, the foreign exchange market is cleared at all times by changes in the exchange rate. Globalization The growing economic interdependence of countries worldwide through increasing volume and variety of crossborder transactions in goods and services, free of international capital flows and more rapid and widespread diffusion of technology. Impulse responses Trace out the pattern of response of current and future values of each of the variables to one unit increase in the current value of one VAR error terms. Managed float system A system with some market by monetary movements to smooth keeping exchange rates Matrix algebra Provides a compact method than scalar algebra in handling regression models. intervention in foreign exchange authorities with exchange rate out short run fluctuations without rigidly fixed. Moving average Linear combination of white noise error terms. Oil price shocks An unexpected disturbance or unexplained movements in oil prices, reflecting the influence by exogenous factors. Price stickiness The tendency of prices to adjust only slowly to changes in the economy. Structural VAR model Combine statistical methodology of basic VARs with a number of widely accepted long run restrictions derived from economic theory to recover the underlying economic shocks. Variance decom position Percentage of the variance of the error made in forecasting a variable due to a specific shock in a given horizon. West Texas Intermediate One of the leading benchmark of high quality crude oil prices which is referred in the United States and the world. x KEYWORDS Exchange rate regimes, Oil price shocks, Macroeconomic variables, Structural VAR model, Malaysia. xi CHAPTER 1 INTRODUCTION 1.1 Introduction The world has started to globalize since the cross border flows of trade has started around 1870s (World Bank, 2005) and economists have been long aware of this global economy trade since the Ricardian theory in 1880s. The realization of the flexible exchange rate regime in insulating the economies against foreign shocks in the early 1950s by Friedman (1953) encouraged the development of floating exchange rate system since early of 1970s. 1 Nowadays, markets for merchandise are much more integrated than ever before. Many developing countries have broken into the world markets for manufactured goods and services since 1980s (World Bank, 2005). This increasing of economic interdependence through the cross border flows of trade and financial can further support through simple proxies as shows in Figure 1.1 and 1.2. Figure 1.1a and 1.1b indicate the index of the openness for goods and services market has increased markedly for many countries especially in the case of Malaysia since 1970s.2 Figure 1.2a and 1.2b show a strong growth in the foreign direct investment (FDI), as proxied by the share of FDI stocks to output. 3 This is further supported by 1 The terms "floating" and "flexible" is used interchangeably. 2The common indicator use to measure the degree of an economy's openness is the percentage of total trade as a share of national income. 3 According to Prasad et al. (2003: 12), stock data is a better indication of capital market integration since it is accumUlation of capital flows through relevant valuation adjustments. 1 Figure 1.1: Trade and Share of Trade to GDP Figure 1.la: World 14,000 ...... c ~ .-------------------------------~ 250 ...... o 12,000 = 200 ~ D. Q 10,000 ~ 0 III ;:) '-" 150 .B 8,000 CII ~ 0 Q, ....E ~ 6,000 o 4,000 - Share of Trade to GOP ~ Export • Import Lett Scale ~ 100 !! a 50 ~ ! 2,000 ~ 'l; Right Scale 0 Q, ~ III a JlI.JJI.1.ILl.I.Ja Year Figure 1.1b: Malaysia 600,000 .-------------------------------~ 250 ...... c ...... o ~ 500,000 200 i D. Q ~ 400,000 ~ ...., 150.B ~ CII 8,300,000 ~ ....E 100 ~ "0 ~200,000 8~ ~ !! o Exports • Imports 100,000 50 ~ III - Share of Trade to GOP a lI'I lI'I .... 01 0 \0 01 .... '".... \0 01 0 lI'I 0 .... 01 .... .... r-. 01 r-. co 01 '"co.... 01 0 g: .... In 01 01 .... o 0 0 0 N Year Source: IMF Prasad et. al. (2003: 15), who indicated that the financial restriction has decreased as financial openness has increased in both industrial and developing countries since 1970s. The factual discussed above shows the cross border trade and capital flows are increasing, which leaves many nations more vulnerable to unexpected international economic shocks. The monitor of the international economic development therefore become crucially important since an economy with relatively 2 Figure 1.2: FDI and Share of FDI to GDP Figure lo2a: World 100 16,000 14,000 ...... c 80 ~ 12,000 iii * ...... 0~ ....., D. Left Scale 10,000 III ;:) ....., 8,000 ~ u 6,000 .2 (II ....C ! D FDI Inward Stocks • FDI Outward Stocks - Share of FOI to GOP 4,000 60 40 20 ! 2,000 0 N 00 0 00 (JI II. ~ III .c (II .,. 0 \0 00 00 00 0 ~ (JI N \0 00 ... ... ... ... ... ... ... ... ... $... (JI ....C.2 ~ Right Scale II. C CJ 00 (JI (JI (JI (JI (JI (JI (JI (JI (JI 0 0 0 N N 0 0 N i!i 0 N Year Figure lo2b: Malaysia 60 100 ...... c SO ...... 80 ....., 0~ iD 40 ~ Left Scale *III ;:) 30 ~ U ....~C II. D. l D FDI Inward Stocks • FOI Outwars Stocks - Share of FOI to GOP 60 .s.... c "0 40 II. 20 .c RlghtScale 20 C CJ + ~ 10 III III 0 0 0 co (JI N co (JI 1li \D co ... ... ... ... (JI 0'1 00 00 0\ ""' 0 ... (JI (JI N 0\ 0\ ""' ~ \D 00 ... ... ... 0\ (JI (JI (JI (JI 0 0 0 N N 0 0 N i!i 0 N Year Sources: IMF and UNCfAD high degree of openness likes Malaysia will be affected more by outside world. As an alternative, the understanding of flexible exchange rates as a tool to mitigate the foreign shocks can help nations to react better to the international economic development, as predicted by Friedman's (1953) hypothesis. 3 1.2 Statement of Problem Malaysia is a small, trade dependent economy with a high degree of foreign presence in both the real and financial sectors. International economic development thus has a significant impact on Malaysian economy. Unexpected change originating abroad from time to time can transmit and affect on the macroeconomic performance, which can be measure by Malaysian macroeconomic variables. On the international context, the direction on the oil prices is a major concern. The changes of international oil prices are uncertainty, for example, there is a slightly declining trend of the oil prices in the late of 2006 by easing political concerns and no expected hurricane season in the United States, instead of continuing increase of price of oil in the early 2000s until a peak in July 2006. Since oil price shocks have a impact on domestic macroeconomic variables, the role of exchange rate regimes in mitigating the impact of these oil price shocks on domestic macroeconomic variables therefore become an interesting issue. This study will investigate the adjustment process of domestic macroeconomic variables in order to test the effectiveness of flexible exchange rates in insulating the Malaysia macroeconomic variables from oil price shocks. 1.3 Research Questions The research questions for this study are stated as follows: 1. Is the long run relationship existed between oil price shocks and domestic macroeconomic variables? 2. Is the oil price shock exogenous within a set of domestic macroeconomic variables? 3. What is the response pattern of each domestic macroeconomic variable to oil price shocks under alternative exchange rate regimes? 4 4. Is the response pattern of domestic macroeconomic variables the same to the oil price increases as to the oil price decreases? 5. How importance is the oil price shocks in explaining the overall variance of domestic macroeconomic variables? 1.4 Objectives of Study The purposes for this study are stated as follows: 1. To examine the cOintegration and exogeneoty of oil prices with domestic macroeconomic variables. 2. To analyze the insulating properties of floating exchange rate regime against fixed exchange rate regime from the oil price shocks. ExpliCitly, the adjustment process of exchange rates, price level and output in response to the oil price shocks is compared under different exchange rate regimes. 3. To analyze the asymmetric effect of the positive and negative oil price shocks on exchange rates, price level and output within and across the exchange rate regimes. 4. To measure the relative importance of the oil price shocks in explaining the overall variance of exchange rates, price level and output. 1.S Significance of Study Different exchange rate regimes have advantages and disadvantages. For example, fixed rate regime can reduce exchange rate volatility and stimulating trade, investment and growth. While economic with floating rate regime has greater ability to adjust to external shocks. This study intends to contribute as a guideline on the effects of the foreign shocks, or unexpected change originating abroad, on the domestic economies under different exchange rate regimes through statistical 5 analysis. An understanding of the insulating properties of exchange rate from foreign disturbances to domestic economies can help the policymakers and investors to monitor international conditions in order to properly react to these undesirable foreign disturbances. Past studies examined on this issue focused on terms of trade shocks, natural shocks and foreign macroeconomic variables shocks such as output, interest rate, price level and money supply shocks (Lastrapes and Koray, 1990; Hutchison and Walsh, 1992; Broda, 2004; Edwards and Levy Yeyati, 2005; and Ramcharan, 2005). On the other hand, studies examine on the relationship between oil price shocks and output did not include the role of the exchange rate (Hamilton, 1983; Mork, 1989; Mork, Olsen and Mysen, 1994, Hooker, 1996; Lee, Ni and Ratti, 1995; Ferderer, 1996; and Guo and Kliesen, 2005). This study fill such a gap in current literature as it focuses on the adjustment process of domestic macroeconomic variables in responses to the oil price disturbances under different exchange rate regimes in Malaysia. 1.6 Scope of Study Instead of asking whether the economic poliCies such as monetary policy, fiscal policy or trade policy can help to stabilize the' output, the study examines if fixed or floating exchange rates can help to achieve this objective. Study is concerned with 'normal times' but not focuses on speCial economic events since there are many interesting economic variations besides these events. And the study is conducted from 1980 to 2005 for Malaysia. 6 1.7 Organization of Study The remainder of the study arrange as follows. Chapter two describes background of this issue in the case of Malaysia. The following chapter reviews the Friedman's (1953) theory and some related literature. Chapter four outlines the econometric framework employs in this study. Chapter five reports the empirical results. And the final chapter provides a summary and implications of the study's findings besides discusses some limitations and suggestions for future study. 7 CHAPTER 2 BACKGROUND OF STUDY 2.1 Introduction Chapter two briefly reviews the important of the international world crude oil prices in influencing Malaysian economy and the development of exchange rate regimes in Malaysia. 2.2 Malaysia as a Price Taker of Crude Oil Malaysia is a crude oil producer and a net exporter country of crude oil. Since the consumption of the crude oil is less than the production capacity in Malaysia as shows in Figure 2.1, Malaysia is exporting the crude oil. At the same time, Malaysia also importing crude oil for consumption as Malaysia can earn more from the higher quality of produced and exported crude oil, namely Tapis. Figure 2.1 indicates that the gap for the volume of exports against imports, and the production compare with consumption of crude oil become smaller over 1990 to 2004. This is further proven through Table 2.1, which shows the share of crude oil production to gross domestic product (GDP) and percentage exports of crude oil to total exports in Malaysia indicates a declining trend. Moreover, the share of the crude oil production in Malaysia to the world crude oil production is less than 2%. Therefore, Malaysia is a crude oil price taker from international crude oil market since Malaysia is a small oil producer country as compare with the world crude oil production. 8 Figure 2.1: Malaysia Production, Consumption, Exports and Imports of Crude Oil 50,000 800 45,000 ....... 40,000 1/1 GI c 35,000 c 0 Ic 30,000 ~ i...., 25,000 "0 GI 15,000 l10,000 I!! 700 CJExport _Import Production - - Consumption ,, " -- .. --., *"-- - _ .. 600 Q ...GI 500 a. Qj 400 I: III CD Left Scale 20,000 300 ! -g ~ 200 0 .e 100 I5,000 ° >III Right Scale 0 Cl'I Cl'I ..... N Cl'I Cl'I ..... (J; '"..... \D Cl'I IX) '"'"..... '"..... 0 0 0 N g N 0 0 N 0 0 N Year Source: Department of Statistics, Malaysia and EIA Table 2.1: Malaysia Production and Exports of Crude Oil Percentage Percentage Year PG EE PP Year PG EE PP 1991 1992 1993 1994 1995 1996 1997 8.98 8.63 7.54 7.32 8.19 7.66 7.27 10.79 8.80 6.54 4.25 3.62 3.66 3.20 1.07 1.09 1.06 1.06 1.09 1.09 1.07 1998 1999 2000 2001 2002 2003 2004 7.88 7.93 7.31 7.18 7.17 7.20 6.98 2.63 2.89 3.82 3.34 3.25 3.94 4.53 1.08 1.05 1.01 0.97 1.04 1.07 1.05 Sources: Department of Statistics, Malaysia; Ministry of Finance, Malaysia; and EIA PG: Share of Malaysia crude oil production to Malaysia GDP Note: EE: Share of Malaysia crude oil export to Malaysia total export PP: Share of Malaysia crude oil production to world crude oil production 2.3 Impact of Changes of Oil Prices on Malaysia Oil is a primary commodity for the world economy - as a raw material in manufacturing industries and is a source of transport fuel. It therefore has an inelastic demand in the short term, in which a slightly drop in crude oil supply will result in large hikes in the international oil prices. 9 Figure 2.2: Prices of Crude Oil and Petroleum Products Figure 2.2a: World Prices of Crude Oil 80 .------------------------------, June 2006_ 70 60 SO 40 30 20 10 0 ~ N ILl ID r-- 00 C7\ 0 M C7\ C7\ C7\ C7\ CTI C7\ C7\ C7\ C7\ C7\ 0 C7\ C7\ C7\ CTI CTI CTI C7\ C7\ C7\ C7\ 0 0 "'" ..... ..... ..... ..... ..... ..... ..... ..... ........ N .... 0 0 N g N M 00 00 0 NN N ILl ID 0 0 N 0 0 N Year Figure 2.2b: Malaysia Retail Prices of Petroleum Products 2.0 - , - - - - - - - -- - -- Petrol Premium (RM/litre) - - Petrol Regular (RM/litre) - - Diesel (RM/litre) 1.5 - LPG (RM/kg) -------, June 2006crT-. 1.0 .J .-, " ~ - ----- - ------~----~-0.5 ... ... ... ... 0 0'1 0'1 0'1 0'1 V N M 0'1 .... .... 0'1 0'1 0'1 0'1 0'1 LrI 0'1 0'1 ...

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