Impact of the Inflation and Remittance on Real GDP Growth of Nepal

Name of Student (roll number)

BBA term name

Email: email address

Econometrics

Course Instructor

Name of Instructor

Month, Year
Introduction

Worker remittances have been recognized as an important and stable source of foreign income in

developing countries (Khathlan, 2012). It has been found to promote economic growth as well

(Mundaca, 2009). It is one of major source of foreign exchange reserve in Nepal as well. It

accounts for average of 71.6% of the foreign exchange reserve from 2003 to 2016 (Ministry of

Finance, 2016). Remittance inflow is on average of 20% of GDP (at producer’s current price)

from 2003 to 2016 (Ministry of Finance, 2016). This fact put the question that if remittance

inflow affect the Real GDP growth as well. Hence this paper will examine whether Remittance

inflow can explain the Real GDP growth.

Similarly the current study also examine the impact of inflation on Real GDP growth. There is

mixed view on impact of inflation on economic growth. Kormendi and Meguire (1985) found to

have negative impact of inflation on economic growth. The study carried out by Bhusal and

Silpakar (2011) stated that inflation rate of 6% threshold have positive influence on economic

growth and beyond or below that threshold can deter the GDP growth.

Remittance and Inflation both have effect on GDP growth as evident from the past study carried

in isolation of each factor separately. The present study will examine the impact of remittance

inflow and inflation rate in Real GDP growth rate in Nepal. Hence, the present study will include

both the factor in single model to examine their impact on GDP growth.
Research Methodology

Data

The current study used the secondary data source for the study purpose. The current study have

taken the data for the real GDP growth, inflation and remittance inflow for the period of 17 years

from 2000 to 2016. The data has been taken from Ministry of Finance 2010, 2015 and 2017.

Variable of the Study

The current study consider the impact of inflation and remittance inflow on Real GDP growth in

Nepal. Hence, the variable of the study include inflation, remittance and Real GDP. And

additional dummy variable has been introduced to capture the negative shock experienced by the

economy.

Real GDP growth: It is annual percentage change in real GDP at basic price as provided by

Ministry of Finance 2010, 2015, and 2017. Real GDP at basic price is GDP at market price

minus taxes and subsidies on product adjusted to the inflation.

Inflation: Inflation can be defined as persistent increase in general price level. For the current

study inflation has been taken as the annual percentage change in consumer price index.

Remittance Inflow: Remittances refer to that portion of migrants’ earnings sent from the

migration destination to the place of origin. Even though they can also be sent in kind, the term

‘remittances’ is normally limited to denote monetary and other cash transfers transmitted by

migrant workers to their families and communities (Pant, n.d).

Shock Dummy Variable: The current study also used the shock dummy variable for the model.

Shock dummy variable would take value 0 if Shock has emerged and depict marginal or

minimum GDP growth. Nepal experience the major earthquake in year 2015 which affected the

GDP growth rate of fiscal year 2014/15 and 2015/16. Similarly, in year 2001 Royal Massacre

resulting arson, terror and violence happened. As a result, the basic tenet of the state to protect

life and property of its citizen on the part of the government overshadowed the priority to

development works. Under the situation, the government was forced to declare the state of

emergency in the country (Ministry of Finance, 2002). Hence, to account these events, shock

dummy variable has been introduced in the model.

The following table shows the descriptive statistics of the quantitate variable used in the current

study.

Table No. 1: Descriptive Statistics of Variable

Standard
Variable Observation Mean Deviation Minimum Maximum
Real GDP Growth (%) 15 3.99 1.57 0.01 6.9
Inflation (%) 15 7.71 2.45 4 12.6
Remittance (Rs. Billion) 15 301.74 234.76 47.54 699

Method

Multiple Linear regression model has been used for the regression analysis and diagnostic

approach has been used to justify the appropriateness of the model. Real GDP Growth is the

dependent variable and Inflation, Remittance and shock dummy are the independent variables.

The analysis has been done with stata 13.

Model

The past study (Bhusal and Silpakar, 2011) have used the log-linear model to explain the impact

of inflation on GDP growth model. Similarly, Khathlan (2012) also have used the log-linear

model to explain the impact of remittance on real GDP growth. However, the current study has

used the following linear regression model to explain the Real GDP growth. The current study

used Log- lin model for the robustness of the study.

Model

RGDP_Growth =0 + 1INF + 2REM + 3QUAKE + ui

Where

RGDP_Growth = Annual percentage change in Real GDP at basic price representing real GDP

growth;

REM= Remittance inflow measured in billion rupees.

INF = Inflation rate as measured by change in Consumer price index

Shock = Shock variable wherein if shock occurred 0 else 1

Result and Discussion

Model Outcome

RGDP_Growth =0 + 1INF + 2REM + 3QUAKE + ui -------------------------- (1)

Table No.3: Model Summary of Original Model

Source SS df MS Number of obs 17.0000

Model 39.9708 3.0000 13.3236 F( 3, 13) 15.5900
Residual 11.1136 13.0000 0.8549 Prob > F 0.0001
Total 51.0844 16.0000 3.1928 R-squared 0.7824
Adj R-squared 0.7322
Root MSE 0.9246

GDP_growth_per Coef. Std.Err t P>|t| [95% Conf. Interval]

Inf -0.2358 0.0994 -2.3700 0.0340 -0.4506 -0.0210
Shock 4.5311 0.6651 6.8100 0.0000 3.0943 5.9679
Rem 0.0045 0.0012 3.6100 0.0030 0.0018 0.0072
Constant 0.5746 0.7858 0.7300 0.4780 -1.1230 2.2721

Table 3 shows the result for the model 1. The beta coefficient of inflation(Inf), Shock dummy

variable (Shock) and Remittance (Rem) is significant at 5% level of significant as P>|t| <0.05.

Similarly, the overall model is also significant at 5% level of significant as P>F <0.05. The

interpretation of beta coefficient and R-square is provided in below.

Inflation beta coefficient: On average 1% increase in inflation rate will reduce the real GDP

growth by 0.235%.

Shock beta coefficient: When there is no occurrence of shock, the real GDP will increase by

additional 4.53% increase above 0.574%.

Remittance beta coefficient: When there is increase of remittance inflow by 1 billion rupees,

the real GDP will increase by 0.0045%.

R2= 0.7824: 78.24% variation in real GDP growth rate is explained by the regression line.
Normality Test

Classical linear regression model assumes that ui has normal distribution. Normality assumption

is required to establish the BLUE property of OLS. When the sample size is large, the error

follows the normal distribution as per central limit theorem. Since, the current study has small

sample size, the test of normality need to be examined.

For examining the normality test of the dependent variable, Histogram and Jarque- Bera test has

been used.

Figure No. 1: Histogram for Real GDP Growth

The residual seems to have normal distribution from the above histogram plot. This can be

further tested with the Jarque -Bera test.

Table No. 2: Skewness/Kurtosis tests for Normality

joint
Variable Obs Pr(Skewness) Pr(Kurtosis) Adj chi2(2) Prob>chi2

Real GDP Growth 17 0.1565 0.2303 3.82 0.1482

The Null Hypothesis that the residual is normally distributed cannot be rejected at 5% level of

significance since the P (0.1483)>P (0.05). Hence the residual possesses the normality feature to

carry out the regression analysis.

Test of Multicollinearity

Multicollinearity refers to the existence of perfect of exact linear relationship among independent

variable. The presence of multicollinearity can result into wider confidence interval, most or all

insignificant beta coefficient, high R2. Although we have several tests for multicollinearity

detection, we can suspect the presence of multicollinearity by looking into model outcome itself

without resorting to formal test. For example, if the sign of beta coefficient is not as per theory,

one or many of partial slope coefficient are insignificant yet there is high R2 and significant F

value, then this signals existence of multicollinearity issue. Looking into the model summary of

the current study from table 3, we don’t have such room to suspect the multicollinearity issue.

The sign of inflation slope is expected to be negative since the descriptive statistics from table 1

shows its mean value is 7.71% which is considered as very high and is also above the threshold

(6%) identified by Bhusal and Silpakar ,2011. The sign of Rem and shock dummy is also as per

expectation and all independent variables are individually significant. The R2 is high however, it

below 0.8. The current study, however, employed the formal test as well to examine if there exist

the multicollinearity among the independent variable. Correlation matrix and variance inflation

factor has been used for this purpose.

Table No.4: Correlation Matrix

Inf Shock Rem

Inf 1
Shock 0.1097 1
Rem 0.4725 -0.3479 1
The table 4 shows the correlation between independent variables. The above table shows that

there is no perfect or strong correlation among independent variables.

Table No.5: VIF and Tolerance Level Test

Variable VIF 1/VIF

Rem 1.63 0.615
Inf 1.45 0.6913
Shock 1.28 0.7823
Mean VIF 1.45

The table 5 shows the Variance inflation factor which shows the severity of multicollinearity in

regression analysis. VIF below 4 is considered as good indicator of weak or no collinearity

among the independent variable. The result shows that VIF is below 2 which there is no

multicollinearity problem in the model.

Heteroskedasticity Test

When there is presence of heteroskedasticity issue, the beta coefficient does not qualify the

BLUE property. The beta coefficient will be unbiased and consistent however it will not be best

and efficient. It may arise due to several reason like sample size, outliers in sample, model

misspecification etc. The current study have sample size of 17 only. Hence, we need to carry out

the heteroskedasticity test of the model. Breusch Pagan Test of heteroskedasticity have been

used. It checks if the estimated variance of the residuals from a regression is dependent on the

values of the independent variables. The table 6 shows the result of the test.
 Table No. 6: Breusch-Pagan test for heteroskedasticity

H0: Constant variance

Variables: fitted values of GDP_growth_per

chi2(1) = 0.69
Prob > chi2 = 0.4075

Since, the Prob (0.4075) > 0.05 the null hypothesis that there is constant variance cannot be

rejected. Hence, the error term is homoscedastic that is there is no heteroskedasticity issue in

regression model.

Autocorrelation test

Autocorrelation may be defined as correlation between members of series of observations

ordered in time [as in time series data] or space [as in cross-sectional data]. In the regression

context, the classical linear regression model assumes that such autocorrelation does not exist in

the disturbances u (Gujarati, 2004). Since, the current study used the time series data for the

study, we need to check for the possibility of the autocorrelation. The current study has used

Breush-Godfrey or LM test to examine the existence of autocorrelation in error term.

Table No. 7: Breush-Godfrey of Autocorrelation test

lags(p) chi2 df Prob > chi2

1 1.162 1 0.2811
H0: no serial correlation

The result from table 7 shows that null hypothesis of having no first order serial correlation

cannot be reject at 5% level of significant and P (0.2811) >0.05. Hence, there is no issue of auto

correlation.
Model Specification Test

Classical linear regression model assumes that model is correctly specified. Model specification

error can arise due to relevant variable omission, including unnecessary variable, wrong

functional form, error in measurement bias and outlier in small sample data set. The current

study used Ramsy’s reset test to detect the possible model misspecification.

Table No.8: Ramsey Reset Model specification test

Ramsey RESET test using powers of the fitted values of GDP_growth_per

Ho: model has no specification error (omitted variable)
F (3, 10) = 0.16
Prob > F = 0.9218

The above table shows that null hypothesis of having no specification error cannot be rejected at

5% level of significance as P (0.9218)>0.05. Hence, the model is correctly specified.

Result Observation and Implication

The current study found that the remittance inflow and rate of inflation affect the real GDP

growth. The study shows the negative impact of inflation on real GDP growth which support the

finding of Bhusal and Silpakar (2011) that above 6% inflation rate is detrimental to economic

growth. The study shows the positive impact of remittance on real GDP growth as remittance

income increases the purchasing power of the recipient and hence increases the consumption

expenditure. Hence, the result outcome supports the past empirical evidence.

The study carried the several diagnostic tools to examine the model adequacy and the study

found the model passes through all these tests. Although the result shows the impact of the

independent variable on GDP growth rate, the coefficient value is very small and marginal. The

R2 value is also sufficiently large to explain the variation in real GDP growth. Hence, the result
outcome is unusual in terms of the impact and explanatory power. There could be several reasons

like the current study include the limited sample size. The nature of data is time series data for

which separate kind of regression treatment is required.

In conclusion, the remittance and inflation have impact on real GDP growth. However, for the

generalization of the result larger sample size test with alternative approach is required.
 Bibliography

Bhusal, T. P., & Silpakar, S. (2011). Growth and Inflation: Estimation of Threshold Point for
Nepal. Economic Journal of Development , 131-138.
Gujarati, D. N. (2004). Basic Econometrics. New York: The McGraw-Hill companies.
Khathlan, K. (2012). The Link between Remittances and Economic Growth in Pakistan: A Boon
to Economic Stability. British Journal of Economics, Management & Trade, 167-185.
Ministry of Finance. ( 2016). Economic Survey. Kathmandu: Ministry of Finance.
Ministry of Finance. (2002). Economic Survey. Kathmandu: Ministry of Finance.
Ministry of Finance. (2004). Economic Survey. Kathmandu: Ministry of Finance.
Ministry of Finance. (2010). Economic Suvey. Kathmandu: Ministry of Finance.
Pant, B. (n.d). Remittance Inflows to Nepal: Economic Impact and Policy Options. Economic
Review, 20-36.
Appendix 1 Data on Study Variable
Annual Change in Real Inflation ( % change in Remittance ( Rs.
Time GDP CPI) Shock Billion)
2000/01 5.4 3.42 1 36.81
2001/02 0.1 2.42 0 47.21
2002/03 3.8 4.8 1 47.54
2003/04 4.4 4 1 58.6
2004/05 3.2 4.5 1 65.5
2005/06 3.7 8 1 97.7
2006/07 2.8 6.4 1 100.1
2007/08 5.8 5.9 1 142.7
2008/09 3.9 12.6 1 209.7
2009/10 4.3 9.6 1 231.7
2010/11 3.9 9.6 1 253.6
2011/12 4.6 8.3 1 359.6
2012/13 3.8 9.9 1 434.6
2013/14 5.7 9.1 1 543.3
2014/15 3.0 7.2 0 617.3
2015/16 0.01 9.9 0 665.1
2016/17 6.9 5.9 1 699