OIL PRICE VOLATILITY AND ITS IMPACT ON ECONOMIC

GROWTH IN PAKISTAN

By

 MUHAMMAD TARIQ HUSSAIN

 OZAIR SIDDIQUE

A research report
submitted in partial fulfillment of the requirements
for the requirement of course title Quantitative Research Method

MAY, 2020
 Acknowledgment
With the blessings of Almighty ALLAH who is most merciful and beneficial, I am very excited

in the direction of present my little contribution to the expansion of some study. I am grateful to

my supervisor, Miss Lubna Khan, without his help, guidance and motivation this work would not

have been possible. The commitment and dedication reflects my work in this thesis, which can

be useful in the future.

I would like to thanks to all my teachers, friends, class fellows and those persons who helped me

to complete this thesis. I am very hopeful that this thesis can be informative to other

professionals.
 Abstract
The main objective of this research is to analyze the impact of oil price volatility on the

economic growth of Pakistan. Secondary data from 2000 to 2019 were used to estimate the

coefficients. Linear Regression analysis is used to analyze the dependency among the dependent

and independent variables. All variable oil price, oil supply, oil demand, gross domestic

production, Public sector investment, private sector investment and Trade balance is stationary at

1st Difference through ADF test. Trade Balance, Private sector investments have a significant

effect on Gross domestic production and Public sector investment, Oil price volatility has

insignificant impact on Gross domestic production. Government should make a proper plan and

procedure according to Pakistan’s economic growth and requirement which would help to

maintain the equilibrium of oil demand and supply and decreased the impact of oil price

volatility on the economic growth. Meanwhile, the government of Pakistan also focused on its

trade balance and also tries to increase private sector investment to increase its economic growth.
 Chapter 1: Introduction
1.1 Background

Oil is the major source of energy. It accounts for about 40% of the global energy

production. As a result of recent shifts in the global market, the effect of oil price volatility

may have a weaker impact on economy. Oil prices have direct impact on the current lifestyle

of the world as it has become one of the most important indicators of the economic activity

all over the world.

The main economic indicators are inflation, foreign direct investment (FDI), gross domestic

product (GDP) and exchange rates. Inflation means that the prices of the goods and services

are generally increased over a time of period. Higher inflation means that the worth of local

currency has decreased. Foreign Direct Investment (FDI) is the measure of foreign ownership

of assets for instance factories, lands and mines etc. for developing economies it is the major

source of financing, it also creates jobs and help the country’s economy to grow. Gross

Domestic Product (GDP) is one of the most important indicators that tell about the health of

the country’s economy. This is basically the measure of country’s total output, everything

produced by all the people and the companies over the year. Exchange rate is the price for

which the currency of a country can be exchanged for another country’s currency. Factors

usually affects exchange rate generally include interest rate, inflation rate, trade balance and

political stability etc.

Afia (2008) Changing oil prices have different impacts on the economy of oil exporting and

oil importing countries. The economies of oil producing companies get boost with increasing

oil price. On contrary, changes in oil prices affects negatively to the oil importing countries.
Any increase in the oil price results in the prices of consumer products, puts pressure on the

exchange rates and increase in import bills.

1.2 Problem Statement

The purpose of this report is to study the impact of oil prices on various economies and asses

the macroeconomic scenario resulting from oil prices.

1.3 Research questions

Q.1 The volatility persistence of crude oil prices has been evaluated

Q.2 The forecasting performance of the above models is compared and contrasted with

forecasting error statistics.

Q.3 Out of sample volatility forecasts are calculated by multiple forecasting horizons, such

as 1, 5, and 20 trading days ahead.

1.4 Research Objectives

1. To understand the causes of oil price volatility.

2. To understand the effect of oil price variation on the different sets of nations viz.

a. Oil importing economy- Pakistan

b. Oil exporting economy- Saudi Arabia

c. Both oil importing and oil producing nation- USA

3. Understanding the role of speculation/ OPEC/ newer technologies like Shale gas on the oil

prices
1.5 Significance of the study

Many studies report that oil price have significance impact on determining the consumer

price inflation as oil is the direct input for many consumer productions and it is used as the

direct input in almost every consumer product.

1.6 Limitation

The results of this study are limited by a relatively short period of data set. Availability of

reliable accessible data in Osiris and Data stream prohibited an extended review of the full

sample. However, half of the crude oil exploration and production companies in Asia have

only records from 2000. By removing all these companies, the sample would not be as

representative as it currently is. Incorporating data from North American and European

companies that extend from 90s would help rectify the imbalance sample.

Chapter 2: Literature Review

The choice of variables used to assess the impact of oil price volatility also differs. Ito

(2010) investigates the impact of oil price shocks on the Russian economy and exchange rate,

using a VAR model to capture the relationship. The empirical results indicate that an increase

in oil prices causes depreciation in the exchange rate and GDP, but the impact of such a

shock results in a marginal positive increment in general prices.

Another study on the Malaysian economy exposed that there exists asymmetric effect

between conditional volatility of oil price; indicating that bad news have more effect on the

conditional volatility of oil prices as compared to good news (Ahmed and Wadud, 2011).
Eksi et al. (2012) again documented that oil is a major input of industrial sector and it is the

main and major constitute of economic growth and economic crisis. When there will be

increase in oil prices, it will lead to inflation because material and production cost will

increase. Thus it will lead to unemployment ultimately.

The prices of oil are going to be high day by day in Pakistan due to our increasing spending

on oil being an oil importer country. In the whole world demand for oil is increasing. Oil

demand increase from 89,203 tons to 597,954 tones in July2012 in Pakistan (Ansar and

Asghar, 2013). To monitor the position of economy of any country the consumer price index

is the significant meter; as the inflation rate has a great effect on the investment and its return

therefore, the financiers must have the up to date knowledge of inflation rate who want to

supply their money in the stock exchange and assess the risk and profit edge.

Jo (2014) investigates how oil price uncertainty affects global real economic activity using

quarterly data from 1958Q2 to 2008Q3. The study utilizes a VAR model with stochastic

volatility, and it is to be noted that the study incorporated realized volatility as an additional

uncertainty indicator. The results indicate that oil price uncertainty shock has significant

negative effects on the world industrial production, the proxy used for economic activity.

Bilgin et al. [2015] apply panel data estimation techniques to data from ten developing Asian

countries and find that world energy price volatility has a negative impact on aggregate

economic activity.

From the foregoing literature review, there is evidence that oil price uncertainty shocks have

an impact on macroeconomic variables such as GDP, investment, savings and stock returns

among others. The literature also suggests an asymmetric effect of oil price uncertainty
shocks on the economy. (See also Baumeister & Kilian, 2016; Charfeddine, Klein, &

Walther, 2018)

Ahmed and Wadud (2017) investigate the effect of oil price volatility on the Australian

equity market. They show that a one period increase or a shock in oil price volatility raises

volatility of equity in consumer discretion, consumer staple, finance, industry, telecom and

consumer staple sectors with equity volatility in industries exhibit a larger and prolonged

positive response compared to the equity volatility response of other sectors.

Elder (2018) examine the effect of oil price volatility on disaggregated measures of industrial

production namely indexes for industrial production excluding technology and moto

vehicles, energy-related special aggregates and non-energy-related special aggregates. They

find the effects of oil price volatility are concentrated in activities related to primary energy

generation and oil and gas drilling relative to other energy-related market groups. In addition,

oil price volatility affects a broad range of special aggregates among the non-energy-related

market groups, including aggregates sorted by consumer goods and business equipment.

Energy price plays a significant role in the economic growth of any country. However, the

change in oil price effect differently on the oil-exporting country and oil-importing country.

Evidence suggest that oil export is a major source of revenue for oil-exporting countries

(Mensah et al., 2019)

 Chapter 3: Research Methodology
3.1 Research Approach

The linear Regression analysis is run on the dependent variable Gross Domestic Production

and the independent variables Trade Balance, Public sector investment, Private sector

investment and the Oil price volatility (defined through standard deviation) to find out the

impact of oil price volatility and other macroeconomic variables on the economic growth of

Pakistan

3.2 Research Purpose

Oil price volatility has become a massive problem for the developed and developing

economies. It has a significant impact on balance of payment and economist pays special

attention in future anticipation to minimize the loss due to oil price volatility. The aim of the

present study is to analyze the oil Price volatility and macroeconomic variables impact on

GDP of Pakistan.

3.1 Research Data

Annual data are collected from Inflation data, Macrotrends, CIEC and World Bank from

2000 to 2019 for estimation of coefficient.

3.4 Research Design

The Linear Regression is an econometric technique which correlates the changes in the

variable (the series data that reappear again at permanent intervals) to other variable or

variables. The demonstration of the association is described as linear regression model. It is

identify linear because the association is linearly preservative. The following Linear

Regression model is used for analysis:

 Gross Domestic Production
=β0 + β1OPV + β2TB + β3PI + β4PSI + ϵ

 OPV = Oil Price Volatility

 TB = Trade Balance

 PI = Public Sector Investment

 PSI = Private Sector Investment

4. Data Analysis
4.1 Unit Roots Results

Unit root test is used to check the stationary of the data. The five variables of time series data

is stationary on the levels and at first difference. The econometrics test Augmented Dickey-

Fuller (ADF) unit root test is used for analysis of stationary The ADF test contains two type

of situation for every time series. First, random selection process includes intercept (C) and

trend (t). Second, random selection process includes intercept (c) but no trend (0). Third,

random selection process includes lag length. There is a trend in oil price. Meanwhile, it is

also anticipating a trend in trade balance, public sector investment, private sector investment

and GDP of Pakistan.

Table: Unit Root Test

Variable Level 1st Difference 
s C C&T C C&T
GDP 0.983 0.011 0.031 0.178
6 9 2
OPV 0.332 0.742 0.003 0.010
7 7 1 4
TB 0.919 0.349 0.004 0.019
3 6 2 1
PI 0.981 0.049 0.076 0.02
3 9
PSI 0.940 0.063 0.023 0.171
1 2 1 5
 The test result indicates that the all variables Oil price, Trade Balance, Public sector

investment, and Private sector investment have a unit root in their levels and are

stationary in their first differences as Table demonstrate the results.

4.2 Cointegration Test

If the variables are found to have unit test roots (nonstationary), and are of the same order

of integration, the cointegration relationship among variables determined. If the variables

are found to be cointegrated, the relationship may be interpreted as a long run

relationship.

Unrestricted Cointegration Rank Test (Maximum Eigenvalue)

Hypothesized Max-Eigen 0.05

No. of CE(s)Eigenvalue Statistic Critical Value Prob.**

None * 0.955727 56.11287 37.16359 0.0001

At most 1 0.659696 19.4025 30.81507 0.5986
At most 2 0.588043 15.96304 24.25202 0.4164
At most 3 0.470597 11.44811 17.14769 0.2779
At most 4 * 0.203249 4.089836 3.841465 0.0431

Max-eigenvalue test indicates 1 cointegrating eqn(s) at the 0.05 level

* denotes rejection of the hypothesis at the 0.05 level
**MacKinnon-Haug-Michelis (1999) p-values

4.3 Regression Test

The linear Regression analysis is run on the dependent variable Gross Domestic

Production and the independent variables Trade Balance, Public sector investment,

Private sector investment and the Oil price volatility to find out the impact of oil price

volatility and other macro-economic variables on the economic growth of Pakistan. The

results are described by the following equation

 GDP = 12.38 + 0.12OPV - 0.21TB + 5.87PI + 0.37PSI

Variabl Std. t-
Coefficient Prob.
e Error Statistic
OPV 0.122424 0.074015 1.654047 0.1189
-
TB -0.211408 0.409384 0.516405 0.6131
PI 5.873561 1.361181 4.315047 0.0006
PSI 0.365225 0.195708 1.866167 0.0817
C 12.38197 5.351951 2.313543 0.0353

R-Sq = 99.63% R-Sq(Adj) = 99.54%

The equation illustrates the constant value of 12.38 units which mean without any change in

other independent variables, the constant independently change the GDP by 12.38 units.

After that the oil price volatility have the coefficient value of 0.12 which is positively

impacted and also depict that one positive change in oil price volatility have positively

change GDP of Pakistan by 0.12 unit. The regression equation also denominates that private

sector investment (which is represented through PSI) has also a positive impact on GDP of

Pakistan and one unit change in private sector investment would change GDP of Pakistan by

0.37 unit. Consequently, the analysis about public sector investment, it has positive impact

on GDP of Pakistan and one unit change in public sector investment may change the GDP of

Pakistan by 5.87 units. In contrast with other independent variable Trade balance have a

negative impact on GDP of Pakistan and if one unit change in Trade Balance would change

GDP of Pakistan by negatively 0.21 units. The table illustrates that trade balance value is

significant at 5 % level of significance. The R square value in the Linear Regression equation

described that the independent variables Trade Balance, private sector investment, public

sector investment and oil price volatility describe the dependent variable Gross Domestic

Production of Pakistan by almost 99 %.

 5. Conclusion

It is observed that the time series data of independent variable and dependent variable (Oil

price, Gross Domestic production of Pakistan, Public sector investment, private sector

investment and Trade balance) have a trend and also not stationary. After using unit root test

(ADF) it is found that all variables are stationary at first difference and no variable is found

stationary at level. The linear regression model is used to find out the effect of oil price

volatility and the other macro economic variables on the GDP. Trade Balance has significant

effect on Gross domestic production at 5% level of significance. Meanwhile, the private

sector investment has a minor effect on Gross domestic production of at 10% level of

significance but oil price volatility and public investment is not significant effect on the

Gross domestic production. The Linear Regression Model describe that these independent

variable define 99% about the dependent variable.

6. References

1. ADB (2004). “Asian Development Outlook 2004”, Asian Development Bank.

2. Afia Malik (2008). “How Pakistan is Coping with the Challenge of High Oil Prices”,

MPRA Paper.

3. K Ito (2010) - “The impact of oil price volatility on macroeconomic activity in

Russia”, econstor.eu
4. HJA Ahmed, IKMM Wadud - Energy policy, 2011 – Elsevier

5. HI Eksi, M Senturk, SH Yildirim - Panoeconomicus, 2012 – “Sensitivity of stock

market indices to oil prices: Evidence from manufacturing sub-sectors in Turkey”

6. I Ansar, N Asghar - IOSR journal of Business and Management, 2013 - academia.edu

7. S Jo - Journal of Money, Credit and Banking, 2014 - Wiley Online Library

8. MH Bilgin, G Gozgor, G Karabulut - The Singapore Economic …, 2015 - World

Scientific

9. Baumeister, L Kilian - Journal of Economic Perspectives, 2016 - aeaweb.org

10. HJA Ahmed, IKMM Wadud - The Journal of Developing Areas, 2017 - muse.jhu.edu

11. J Elder - Macroeconomic Dynamics, 2018 - cambridge.org

12. Mensah, I.A., Sun, M., Gao, C., Omari-Sasu, A.Y., Zhu, D., Ampimah,B.C.,

Quarcoo, A. (2019) Analysis on the nexus of economic growth, fossil fuel energy

consumption, CO2 emissions and oil price in Africa based on a PMG panel ARDL

approach