DOI: 10.5817/FAI2016-3-3 No. 3/2016
37
Cointegration Approach to the Estimation
of the Long-Run Relations between Exchange Rates
and Trade Balances in Visegrad Countries
Jana Šimáková
Silesian University in Opava
School of Business Administration in Karviná, Department of Finance and Accounting
Univerzitní náměstí 1934/3, 733 40 Karviná, Czech Republic
E-mail: simakova@opf.slu.cz
Abstract: The paper deals with the relationship between exchange rates and foreign
trade. The aim of this paper is to reveal the long-term effects of the level of exchange
rates on the trade balances of the Visegrad Countries. As the different product
categories are characterized by different price elasticity, exchange rate uncertainty
sensitivity and countries are differentiated by consumer and producer behavior
patterns, this paper uses territorial and commodity structuring of foreign trade data.
An empirical analysis is performed for the period 1999: Q1-2014: Q3. The effects of
exchange rate levels are analyzed by Johansen cointegration analysis to reveal the
long-term effects. The approach adopted in this study is found to be an acceptable
substitute for testing the Marshall-Lerner condition. Bilateral and majority of partial
trade balances are cointegrated with bilateral exchange rate in the long term.
Although there are some product categories without proved cointegration, the
product categories tending to the long-term equilibrium significantly exceed them.
Based on this analysis it can be stated that the bulk of the total and partial bilateral
trade balances are characterized by a common long-term development with domestic
and foreign GDP and bilateral exchange rates.
Keywords: cointegration, exchange rate, Marshall-Lerner condition, trade balance
JEL codes: F10, F31
Introduction
Exchange rate is one of the variables mediating the impact of external economic
relations on the economic entities in the domestic country and influencing decisions
of particular economic entities to export and import goods and services. Exchange
rate is a quantitative variable that fluctuates over time and this movement, its speed
and extent, affects the prices of goods and services and thus reflects the amount of
the total cost, and revenue from foreign trade and the overall demand and supply of
internationally traded goods. Therefore, exchange rate importance increases
proportionally with the openness of the domestic economy to other countries. A
region with high openness of economies can be represented by the Visegrad Group
(V4). In 2015 the share of trade volume in the GDP was 96% in Poland, 160% in
Hungary, 163% in the Czech Republic and 185% in Slovakia. This group is
constituted of geographically close open economies located in Central Europe, which
have successfully completed the transition process to the market economies. The
38
transformation process influences their foreign trade and exchange rates regime as
well. In this situation, the high rates of participation in foreign trade of V4 countries
and a gradual inclination to floating exchange rates make the V4 eligible for the
research.
In analyzing the relationship between exchange rate and foreign trade, this paper is
based on the balancing process, which means linking the balance of trade with
income and exchange rates. In a system of flexible exchange rates it is possible to
eliminate the trade deficit through currency depreciation. The same principle can also
be used for the system of a fixed exchange rate as a consequence of an official
devaluation. The efficiency of depreciation (devaluation) to cope with the deficit in
the trade balance is assessed by the indirect testing of Marshall-Lerner condition in
this paper. The Marshall-Lerner condition states that the sum of export and import
demand elasticity has to be at least one and then the currency depreciation has a
positive impact on the trade balance. Usually, Marshall-Lerner condition is not met in
the short run, goods tend to be inelastic and depreciation deteriorates the trade
balance initially. In the long run, consumers can adjust to the new prices, volume
effect is generally believed to dominate the price effect and trade balance will be
improved.
Literature concerning the relationship between exchange rates and trade balance
usually fall into one of the following three categories: studies using aggregate trade
data; studies employing disaggregate trade data at the bilateral level; and recent
studies using disaggregate trade data at the commodity level. The first type of
studies concentrates on the use of aggregate export and import data between a
country and the rest of the world in assessing the effectiveness of currency
devaluation (e.g. Felrningham, 1988). These studies have to employ the effective
exchange rate, which can be misleading when the country’s currency appreciates
against one currency and simultaneously depreciates against another currency
(Bahmani-Oskooee and Brooks, 1999). The weighted averaging will therefore smooth
out the effective exchange rate fluctuations, yielding an insignificant link between the
effective exchange rate and the trade balance. Therefore, many other studies employ
bilateral exchange rates and bilateral trade balance data between a country and its
major trading partners (Bahmani-Oskooee and Ratha, 2004). There has been a
growing body of literature arguing that the second-generation study may still suffer
from the aggregation bias problem, as significant exchange rate impacts with some
commodities could be more than offset by insignificant exchange rate effects with
others, thereby resulting in an insignificant exchange rate impact and vice versa.
Therefore, the newest studies disaggregate data to the industry level (e.g. BahmaniOskooee
and Hegerty, 2011; Bahmani-Oskooee et al., 2014; Bahmani-Oskooee et
al., 2016).
The aim of this paper is to reveal the long-term effects of the level of exchange rates
on the trade balances of the Visegrad Countries. As the different product categories
are characterized by different price elasticity, exchange rate uncertainty sensitivity
and countries are differentiated by consumer and producer behavior patterns, this
paper uses territorial and commodity structuring of foreign trade data. Therefore, this
study substantially contributes to scientific discussion in this field and fills the gap in
39
literature about territorial-commodity trade. An empirical analysis is realized for the
period 1999-2014. The effects of exchange rates levels are analyzed by Johansen
cointegration analysis to reveal the long-term effects. Following Arize (1994), the
approach adopted in this study is found to be an acceptable substitute for testing the
Marshall-Lerner condition.
1 Development of Foreign Trade and Exchange Rates in V4
Countries
The V4 countries are Central European countries which with their strategic position
present an important entity for the foreign trade. They passed an important
transformation phase after 1989, during which they reformed the system of centrally
planned economies to the market economies. The new concept has become an
important tool in building competitiveness of their national economies towards
integration into the global market economy and to European structures. The
transformation influenced their foreign trade and exchange rate policy issues as well.
They redirect trade from east to west markets which has caused changed structure
and intensity of trade flows and this trade bloc has turned into a region with a
significant impact on the world foreign trade. However, the liberalization steps of
individual countries have contributed to the growth of openness of the economies to
different degrees.
1.1 Development of Foreign Trade in V4 Countries
As can be seen in Figure 1, the openness of all economies is increasing, but the
growth rate varies across them. Furthermore, each country enters the beginning of
the period with another share of the total foreign trade turnover of their GDP. The
highest degree of openness at the beginning of the sample period was observed in
Hungary (108%). Nevertheless, its growth rate is far below Slovakia, which shifted
from 71% to almost 173% and became the most open economy among the V4
countries. Figure 1 also shows very similar development in the degree of openness of
the Czech Republic and Slovakia.
Figure 1 Openness of the V4 economies
(share of total turnover of foreign trade in GDP in %)
Source: Author's work based on OECD data
40
This development is likely given by the common characteristics of these economies.
The indicator of openness of the Czech economy reached 85% at the beginning of the
period; it increased to nearly 150% in 2014. The dynamics of the growth rate of
openness were variable during the sample period, but a significant increase can be
seen in all cases in 2004, which is most likely related to the accession to the EU.
There can also be observed a common significant decline in 2009 due to the
economic crisis trespassing the region of Central Europe. A vastly different degree of
openness is typical of Poland, which despite doubling of this ratio during the years, is
still beyond the average of the other analyzed countries.
Poland is different from the other countries also in other aspects. As is shown in
Figure 2, a deficit in the trade balance of all V4 countries is observed at the beginning
of the period, but deficit in Poland is the most significant. Although the deficits are
gradually corrected in each country, Poland‘s reduction is the highest one. Slovakia
has the initial deficit mostly due to the lack of industrial restructuring and subsequent
difficulties asserting its companies to foreign markets. There was a price reduction of
imports as a result of the effective appreciation of the Slovak koruna and a further
loss of the price competitiveness of Slovak exports. Another negative factor was
represented by one of the highest unit labor costs among transition economies.
Furthermore, the government policy in the area of foreign loans and government
guarantees was aimed primarily to support the infrastructure with a minimal impact
on the export performance of the Slovak economy. Thus, the return of foreign
exchange obtained through foreign loans became more difficult. The improvement in
the trade balance in Figure 2 can be caused by the change towards the investmentfriendly
economic policies and usage of pro-export tools.
Figure 2 Development of the V4 trade balances
(the share of total exports in total imports)
Source: Author's work based on OECD data
Changes of openness of the Czech economy have been related to the development of
both export and import. They reflected the overall economic situation in the country
and in the major trading partner economies. It can be concluded that the increase in
the level of openness of the Czech economy in the years 1999–2014 was mainly
41
driven by the export growth, which was generally higher than the growth rate of
imports. Increase in Czechia’s openness was caused by the trade policy, by improving
the competitiveness of Czech products in world markets and by the growth of intraindustry
trade occurred from the second half of the 1990s in relation to the
placement of foreign direct investment in the Czech Republic. Foreign direct
investment also helped carry out the necessary structural changes in the economy.
Foreign capital in production helped to change the structure of industrial production
to manufacture products with higher added value and product’s sales in new markets.
This reflected in its positive trade balance.
Both components of foreign trade were increasing due to foreign trade policy in
Hungary during the sample period, but import volumes exceeded the amount of
exports in value terms, which resulted in a negative trade balance. However, trade
balance has been improving on average. According to Fojtíková (2011), this
improvement is caused by a favorable economic situation in Hungary as well as in
other EU countries which became Hungary's main trading partners during the
transition period. Exports were driven by the machinery and transport equipment as
well as by the capital-intensive production.
Territorial Structure of V4 Foreign Trade
Figure 3 shows the territorial structure of major trading partners of the V4 countries
(selected countries represent more than 50% of their total foreign trade turnover).
Figure 3 Territorial structure of V4 foreign trade
(share of total foreign trade of the country in %)
Source: Author's work based on OECD data
0%
10%
20%
30%
40%
19992001 20032005 2007 20092011 2013
CZ FR DE
IT SK GBPL
0%
10%
20%
30%
19992001200320052007200920112013
AT CZ FR
DE HU PLSK
0%
10%
20%
30%
40%
19992001200320052007200920112013
AT FR DE
IT PL GB
HU
0%
10%
20%
30%
40%
19992001 20032005 2007 20092011 2013
AT FR DE
IT PL SK
CZ
42
0%
10%
20%
30%
40%
50%
60%
19992001200320052007200920112013
T0 T1 T2 T3 T4
T5 T6 T7 T8 T9CZ
0%
20%
40%
60%
80%
19992001200320052007200920112013
T0 T1 T2 T3 T4
T5 T6 T7 T8 T9HU
0%
10%
20%
30%
40%
50%
19992001200320052007200920112013
T0 T1 T2 T3 T4
T5 T6 T7 T8 T9PL
0%
10%
20%
30%
40%
50%
60%
19992001200320052007200920112013
T0 T1 T2 T3 T4
T5 T6 T7 T8 T9SK
The similarity of foreign trade pattern is evident. Regional similarity and connection of
producers as well as consumer behavior result in their mutual trade even.
Approximately a quarter of V4 foreign trade is done with Germany as the trend
determining economy and the most important foreign market for Central European
countries. The long-term economic ties between Czechia and Slovakia are also visible
in Figure 3. In general, thanks to barrier-free trade within EU, the V4 countries do the
foreign trade mostly with other member states (almost 80% on average). Non-EU
countries have a lower share in V4 foreign trade focused predominantly on goods as
cheaper equivalents (USA, China), goods from strategic partners (Russia) or domestic
country of foreign direct investment (South Korea).
Commodity Structure of V4 Foreign Trade
Figure 4 shows the visible dominance of machinery and transport equipment in V4
foreign trade. These trade flows represent 47% share in Czechia, 57% share in
Hungary, 37% share in Poland and 44% share in Slovakia on average during the
sample period. Manufactured goods with 20% share (13% for Hungary) are the
second major product categories in terms of foreign trade. Another 10% share falls to
miscellaneous manufactured articles. These characteristics clearly determine the V4
foreign trade.
Figure 4 Commodity structure of V4 foreign trade (share of individual product trade
of the total foreign trade in %)
Source: Author's work based on OECD data
43
1.2 Development of Exchange Rates in V4 Countries
Development of exchange rate policies of V4 economies can be also considered one
of the key attributes associated with the fundamental economic and political decisions
after the start of the transformation process in 1989. Mirdala (2011) notes that
despite specific individual features of this process, we can mention several similar
facts. The common characteristics can be illustrated by the starting position after
1989; the development of basic macroeconomic proportions during the first decade of
the transition process; and the same goal, which was the accession to the EU and the
subsequent adoption of the euro (EUR). Ongoing specific processes during the
transition period were associated with significant economic transformation,
development and deregulation of the various sub-markets and changing of relative
prices patterns. These processes fundamentally determine the terms and conditions
of formation of long-term trends influencing the competitiveness of V4 foreign trade.
V4 countries applied the system of fixed exchange rates at the beginning of the
transformation process. This instrument was considered the most effective tool in
fighting against inflation and reducing the disinflation process costs. This approach is
based on the fact that most transition countries show signs of small open economies.
One of the main factors influencing the selection of an appropriate strategy for the
exchange rate system in the V4 countries at the beginning was the need for a stable
macroeconomic environment, accessibility and volume of foreign exchange assets
(reserves) and the overall level of economic openness. Later changes of the exchange
rate system were affected by the ability of these countries to manage economic
activities conditioned by the international capital movements and in practical terms,
they were affected by institutional factors related to their future accession to the
European Exchange Rate Mechanism II (ERM II). Mirdala (2011) states that after the
completion of the EU accession process in 2004, these countries achieved greater
stability of exchange rates of their national currencies in relation to the euro. EUR has
played an important role in the exchange rate policies of the V4 countries since its
inception - in the form of a nominal anchor, reference currency and as the main
indicator of the exchange rate development.
Figure 5 Development of V4 REER
(Index with 18 Major Trading Partners, CPI Deflator)
Source: Author's work based on Eurostat data
44
Czechia and Slovakia applied the managed float system during the whole sample
period. Poland shifted from fixed exchange rate parities to free floating in April 2000.
Hungary first expanded the oscillating band to ± 15% in the fixation of the Hungarian
forint (HUF) to EUR in May 2001 and then adopted the managed float system with
EUR reference currency. The real effective exchange rate (REER) can be seen in
Figure 5. The biggest changes in the sample period were reported for the Slovak
koruna (SKK), which entered the ERM II system with central rate set at 38.4550
SKK/EUR in November 2005. The central parity of the Slovak koruna was revalued to
35.4424 SKK/EUR in March 2007 and to 30.1260 SKK/EUR in May 2008. In 2009,
Slovakia adopted the EUR currency as the first V4 country. Mirdala (2011) states that
exchange rate policies of the Czech Republic, Hungary and Poland are fully compliant
with the assumptions to enter the ERM II system. The decision on the accession of
these countries’ currencies into ERM II can therefore be considered rather a question
of an overall ability for EMU (European Monetary Union) accession and the ability to
sustainably fulfill the convergence criteria. The last financial crisis might be one of the
reasons for considerations about the national currencies of the remaining V4
countries to enter the ERM II . Exchange rate instability and currencies’ depreciation
against the euro was particularly evident during the first half of the year 2009.
Moreover, Czech koruna vis-à-vis the euro has been adopted by the Czech National
Bank as a regular monetary policy tool since the third quarter of 2013.
To summarize, the exchange rate policy of HUF and PLN (Polish zloty) applied until
1999 did not lead to the reduction of deficits of their trade balances. The following
shift of PLN to floating regime allowed Poland to reduce real appreciation of PLN
without a significant impact on the trade balance. Fixation of HUF to EUR caused
significant real appreciation of HUF followed by the worsening of the trade deficit. The
real currency appreciation in the Czech Republic and Slovakia was related to the high
real economic growth after 2000, enabling these countries to maintain a competitive
position in international markets. Currency interventions of the Czech National Bank
play an important role in the improvement of the Czechia’s trade balance. Contrary to
Czechia, the Euro adoption does not allow for a more significant improvement of the
trade balance in Slovakia.
2 Empirical Estimation and Results
This study employs a reduced form of trade balance model by Rose and Yellen (1989)
to analyze the long-run effects of changes in exchange rate on the trade balance. The
trade balance is expressed as a function of exchange rate and the domestic and
foreign income. The Johansen cointegration procedure is applied to avoid the main
criticism of early studies, whose results could suffer from spurious regression problem
because of non-stationary data. For empirical analysis of tested trade flows, the
model is specified as follows (1):
ttftftdtp ERYYTB ελχβα ++++= ,,,, lnlnlnln (1)
The variable of trade balance TB is calculated as a ratio of export to import in
bilateral flows with key trading partners. The paper further assumes that foreign
45
exchange rates can affect the individual product-level trade balances in different way.
The analysis therefore constructs variable TBp as a share of export to import in each
SITC (Standard International Trade Classification) product category in tested bilateral
trading flows. Incomes of individual countries Yd for domestic country d and Yf for
foreign trading partner f are represented by GDP in current prices, and are converted
into an index form, to calculate the unitless value. Exchange rates ER are calculated
as a quarterly average of monthly nominal exchange rate in direct quotations. The
exchange rate is defined in a manner that an increase reflects a depreciation of the
domestic currency. ε represents an error term. Since an increase in foreign income Yf
is expected to increase the exports to respective country, an estimate of γ is
expected to be positive. Contrary, since an increase in domestic income Yd is
assumed to increase the imports, an estimate of β is expected to be negative. Finally,
the parameter λ is expected to be positive as the trade balance of respective industry
should improve due to domestic currency depreciation. All time series used for
estimation are in the quarterly frequency and cover the period from 1999:1 to
2014:3. Estimated product groups representing the commodity structure of trade in
selected sectors are determined on the basis of SITC classification:
• TT: Total trade;
• T0: Food and live animals;
• T1: Beverages and tobacco;
• T2: Crude materials, inedible, except fuels;
• T3: Mineral fuels, lubricants and related materials;
• T4: Animal and vegetable oils, fats and waxes;
• T5: Chemicals and related products;
• T6: Manufactured goods;
• T7: Machinery and transport equipment;
• T8: Miscellaneous manufactured articles;
• T9: Commodities and transactions not classified elsewhere in the SITC.
In the case of Slovakia, the time series of trade flows with AT, DE and FR are
shortened to the period 1999:Q1 – 2008:Q4, due to the adoption of the euro as the
official currency in 2009. Other data cover the period 1999:Q1 - 2014:Q3 and mean
63 observations on a quarterly frequency. All time series are modified by logarithmic
transformation. ADF (augmented Dickey–Fuller test) stationarity test results confirm
the integration of I(1) for all variables, which is the assumption for the Johansen
cointegration analysis employed to test the long-term relationships. The presence of
long-term bonds between the variables is assessed on the basis of Trace and
Maximum eigenvalue test.
2.1 Testing of Lags and Cointegration Equations
The lag structure of variables in the model has a significant impact on the conclusions
adopted on the basis of the model. Lags in empirical literature are usually centered
around two years. In many countries, however, this period varies across trading
partners because of the different nature and flexibility of traded goods and time
needed for consumers’ adaptation (Auboin and Ruta, 2013). The optimal lags in this
paper are determined by maximizing the Schwarz information criterion. Values can be
seen in Tables 1–4. One lag means delay a of one quarter. These tables also show
46
the results of Johansen cointegration test on the number of existing cointegration
vectors (r). The existing long-term relationship between variables is proved if r≠0.
Table 1 Number of lags and cointegration equations for Czechia
AT DE FR IT PL SK
lag r lag r lag r lag r lag r lag r
TT 4 1 2 1 2 1 4 1 2 1 2 1
T0 4 1 2 1 2 1 2 2 2 2 2 1
T1 4 1 2 0 2 1 2 0 2 1 2 1
T2 4 1 2 1 3 1 2 1 2 2 2 1
T3 4 0 2 1 4 1 2 1 2 1 2 1
T4 4 0 2 0 4 0 2 0 2 0 2 0
T5 4 1 4 1 5 1 2 1 3 1 5 1
T6 5 0 4 1 9 1 5 0 2 1 5 1
T7 5 1 4 1 9 1 9 1 3 1 5 1
T8 5 1 9 1 9 0 9 1 4 1 9 1
T9 5 0 4 0 5 0 5 0 4 0 4 0
Source: Author's calculations
The empirical estimates of the effects of the level of foreign exchange rates on the
trade balance for the Czech Republic is provided for trading partners AT, DE, FR, IT,
PL and SK. The sum of their average shares in the total foreign trade is 58% in the
sample period and results can be seen in Table 1. The optimal lags calculated for
each trading partner in various product categories show that the average delay in
product groups T0 to T4 is lower than in the other categories tested. This confirms
the assumption of Auboin and Ruta (2013) that the lower lags in these product
categories are affected by the higher substituting. Johansen cointegration test results
on the number of existing co-integration equations say that the aggregate bilateral
trade balances TT are in the long-term relationship with exchange rate movements,
but exceptions can be found at the product level. No cointegration vector was
estimated for product categories with animal and vegetable oils, fats, waxes and too
heterogeneous category of commodities and transactions not classified elsewhere.
Animal and vegetable oils, fats and waxes belong to the product category
characterized by a substantially smaller share in the total foreign trade. For the Czech
Republic it is less than 0.1% in the sample period. The territorial structure shows that
a lower amount of long-term relationships is estimated in trade with AT and IT. In the
case of AT, it means 31.3% of product categories bilaterally traded without long-term
relationship. In the case of IT, it is 27.3% of bilateral foreign trade. In other trading
flows there is no long-term cointegration proved only for less than 1% foreign trade.
Therefore, it can be concluded that the individual trade balances are characterized by
a long-term joint development of Czech GDP, GDP of trading partners, as well as a
bilateral exchange rate.
The empirical estimates for Hungary (Table 2) were provided for trading partners CZ,
DE, FR, GB, IT and SK. The sum of their average shares in the total foreign trade is
51% in the period. The optimum lag for AT is approximately one year in all product
categories, with exception of food, live animals and crude materials. It is not possible
to specify lags for Hungary by the commodity structure, but we can observe lags
47
higher than five quarters only in categories of manufactured goods and miscellaneous
manufactured articles. Johansen cointegration tests for Hungary show a significantly
lower number of cointegration vectors in comparison to the Czech Republic.
Table 2 Number of lags and cointegration equations for Hungary
AT DE FR GB IT PL
lag r lag r lag r lag r lag r lag r
TT 4 1 9 1 3 1 1 1 5 1 2 1
T0 2 0 4 2 2 1 2 1 4 1 4 1
T1 4 1 5 1 2 1 4 0 4 1 4 1
T2 2 1 5 0 4 0 4 0 4 1 2 2
T3 4 1 5 0 4 0 4 0 4 0 2 0
T4 5 0 5 2 5 0 4 0 4 0 4 0
T5 4 1 4 1 3 1 4 0 6 1 2 0
T6 4 1 8 2 5 1 9 0 5 2 4 1
T7 5 0 8 2 3 1 1 1 7 2 5 2
T8 4 1 9 1 4 1 8 1 9 0 6 2
T9 5 0 4 0 5 0 4 0 4 0 2 0
Source: Author's calculations
Despite the long-term equilibrium of exchange rates with the total bilateral trade
balances, disaggregating to the partial trade balances shows significantly different
results. GB manifests a long-term relationship only in three partial trade balances.
However, the overall bilateral cointegration is probably given by the dominance of
shares of these three foreign trade components (machinery and transport equipment
– 66%; miscellaneous manufactured articles – 8%; food and live animals – 3%).
There were estimated more cointegration equations in trade flows with AT, but sum
of the product-level trade balances is only 52% of total bilateral foreign trade. No
long-term relationship was proved for 20.6% of foreign trade realized between
Hungary and PL and 16.3% between Hungary and IT. In case of DE and FR can be
observed statistically significant tendency to common movement with exchange rates
in case of more than 95% share on total bilateral foreign trade.
Table 3 Number of lags and cointegration equations for Poland
CZ DE FR GB IT SK
lag r lag r lag r lag r lag r lag r
TT 4 1 2 1 4 1 4 0 4 1 2 2
T0 4 1 2 1 2 0 4 2 2 1 2 1
T1 4 1 2 1 2 1 5 0 2 1 2 1
T2 4 1 2 1 4 0 8 1 2 1 2 0
T3 4 1 2 1 4 0 5 0 2 0 2 0
T4 4 0 5 0 4 0 5 0 2 0 5 0
T5 4 2 4 1 4 2 4 0 2 1 2 1
T6 4 1 5 1 9 1 9 1 9 1 9 1
T7 4 1 6 1 9 1 9 1 9 1 9 1
T8 6 1 6 1 9 1 8 2 9 1 9 1
T9 5 0 4 0 5 0 5 0 4 0 2 0
Source: Author's calculations
48
The empirical estimates for Poland are for trading partners CZ, DE, FR, GB, IT and SK
and are presented in Table 3. The average share of selected trading partners in the
total foreign trade is 52% in the sample period. The optimum lags calculated for each
trading partner in individual product categories show higher lags in trade with
manufactured goods, machinery and transport equipment and miscellaneous
manufactured articles. These results are similar to the case of Czechia. Results of
Johansen cointegration test show that aggregate bilateral trade balances are in longterm
equilibrium for all trading partners except GB. GB represents on average a 5%
share in the total foreign trade of Poland and its share of cointegrated product
categories represents 48.6% of total trade. This is likely to translate into overall
relationship without a long-term equilibrium. The lower number of cointegration
vector was also demonstrated in the case of FR, where up to 5 estimated trade
balances are not in the long-term relationship with GDPs of Poland and FR and their
bilateral exchange rate. However, this trade represents only 8% of the total foreign
trade between Poland and FR. Other estimated trading partners are characterized by
long-term bond in product categories representing more than 95% of the trades. The
cointegration in the case of trade with animal and vegetable oils, fats, waxes and
residual commodities and transactions was not confirmed for Poland.
Table 4 Number of lags and cointegration equations for Slovakia
AT CZ DE FR HU PL
lag r lag r lag r lag r lag r lag r
TT 4 1 2 1 2 1 4 1 2 1 4 1
T0 4 1 2 1 2 1 2 2 2 2 2 1
T1 4 1 2 1 2 1 2 1 2 1 2 1
T2 4 1 2 1 2 1 2 1 2 1 2 1
T3 4 1 2 1 4 1 2 1 2 1 2 1
T4 5 0 5 0 4 0 5 0 2 0 2 0
T5 4 1 4 1 2 1 4 1 2 1 2 1
T6 9 0 8 1 9 1 9 0 8 1 9 2
T7 9 1 9 2 9 1 9 1 8 1 9 2
T8 9 1 9 1 9 1 9 1 8 1 9 1
T9 5 0 4 0 5 0 9 0 4 0 5 0
Source: Author's calculations
Empirical estimates for Slovakia were provided for trade flows with partners AT, CZ,
DE, FR, HU and PL (Table 4). Their average shares in the total foreign trade of
Slovakia are 55% in the sample period. Trade with manufactured goods, machinery
and transport equipment and miscellaneous manufactured articles is also in this case
characterized by higher lags. Johansen cointegration test results suggest that all
aggregate bilateral trade balances are in the long-term relationship. However, we can
find exceptions at the product-level. Similar to Hungary and Poland, there is no longterm
relationship between exchange rates and Slovakia’s trade balances of animal
and vegetable oils, fats, waxes and residual commodities. A lower amount of longterm
relationships was demonstrated in partial trade balances with AT (32% of the
total trade between countries).
49
2.2 Testing of Long-term Effects
Estimated coefficients of long-term effects of individual explanatory variables included
in the model for bilateral and product-level trade balances with proven long-term
tendency for joint movement are shown in Table 5-8.
Table 5 Estimated coefficients of long-term effects for Czechia
AT DE FR IT PL SK
Yd Yf ER Yd Yf ER Yd Yf ER Yd Yf ER Yd Yf ER Yd Yf ER
TT -5.32 1.47 -1.27 0.42 0.86 0.20 0.38 1.34 -0.23 0.21 1.53 1.27 1.29 1.02 3.55 -3.74 3.10 -0.16
T0 8.36 0.47 2.37 -4.14 2.05 -1.10 -1.62 3.79 -1.97 2.75 1.41 -0.39 2.63 -2.85 2.45 -0.53
T1 -3.24 6.39 -1.51 x x x -6.75 3.31 1.87 x x x -0.07 0.90 0.65 0.53 0.12 0.74
T2 -8.20 2.71 -1.76 -9.74 2.43 -0.27 1.31 -1.27 0.23 3.75 -1.15 -1.26 1.32 1.71 5.55 -4.15 0.22
T3 x x x -10.21 0.06 -0.26 9.31 -2.17 0.11 7.18 -2.36 1.87 1.04 0.84 0.56 -8.50 7.62 -0.89
T4 x x x x x x x x x x x x x x x x x x
T5 -2.85 1.92 -0.63 5.01 -3.62 1.29 -0.26 4.57 2.62 6.77 -2.33 -1.94 -3.14 1.76 -2.81 0.45 -0.11 0.35
T6 x x x -0.00 1.01 1.59 0.06 1.69 2.42 x x x 0.93 -0.96 0.22 -1.32 0.94 -0.11
T7 -5.07 -2.17 0.09 0.51 0.18 -1.27 4.73 -2.67 6.65 -3.10 -2.04 -2.49 0.44 -0.82 -6.76 3.64 0.29
T8 -2.39 2.35 -1.75 -0.84 0.50 -0.50 x x x 3.68 1.21 0.90 0.13 0.53 0.71 0.08 -0.38 0.66
T9 x x x x x x x x x x x x x x x x x x
Source: Author's calculations
The analysis of long-term coefficients of domestic GDP for the Czech Republic shows
differences across product categories and also across trading partners. Negative
effects of domestic GDP on the trade balance is proved in trade with AT (except trade
with food and animals - 3.5% of total trade). With the Czechia’s GDP growth we can
expect an increase in quantity demanded for Austrian goods in the country and thus
increase in good’s import, which leads to a worsening of the trade balance and is
reflected in the negative effect on the total bilateral trade balance. A similar
conclusion is also estimated for SK. The negative effect of Czech GDP is reflected in
the total bilateral trade balance, as well as in the partial trade balances representing
74% share of bilateral trade with Slovakia. Cointegration analysis on the bilateral
level proved the opposite relationship with domestic GDP for trading partners DE, FR,
IT and PL. This conclusion was also confirmed by positive coefficients estimated for all
cointegrated partial trade balances in the case of trade flows with IT. However,
product-level analysis of other trade flows does not support the overall bilateral
estimation. Consistent conclusion of bilateral and product-level trade balances in the
case of DE is proven only by a 19% share in total bilateral trade with DE, 29% with
NL and 36% with PL. The results thus clearly show the possible bias resulting from
the aggregation of data.
50
Coefficient estimation of foreign partners’ GDP provides clearer conclusions. All
trading partners’ GDP have the positive effect on total bilateral trade balances of the
Czech Republic. GDP increases in foreign economies can thus be approximated with
an increase in the purchasing power of foreign entities, increase in the quantity
demanded for domestic goods abroad and therefore an increase in exported goods.
The highest rate was demonstrated for Slovak GDP, which clearly shows the
interdependence of these economies. However, there also opposite effects on the
commodity level can be found. In the case of trade with AT, it is a product category
representing 38% of bilateral trade, for DE category with an 8% share, for FR
category with a 12% share, for SK category with a 23% share, for PL category with a
37% share and for IT category up to a 57% share in bilateral foreign trade.
The results presented in Table 5 also show that the positive effect of Czech koruna
depreciation on the total bilateral trade balances can be found in trades with DE, IT
and PL. Total average share of these countries in the total foreign trade turnover of
the Czech Republic is 39% in the sample period. In trade flows with AT the bilateral
negative coefficient is also supported by the product-level analysis (except trade with
food and live animals). The effects of exchange rate on other partial trade balances
are mixed. Dominance of the positive effect of Czech koruna depreciation can be
observed in the cases of DE, PL and SK. These effects can be observed in 79%, 77%
and 53% share of total bilateral trade balances. This analysis also shows that
depreciation of the Czech koruna against the euro promotes exports and reduces
imports in most of trade with DE on one hand, but on the other hand, the same
exchange rate movement improves the trade balances with FR only for 29% share,
for IT 16% share and for AT even only 4% share of tested commodity trade balances.
Table 6 Estimated coefficients of long-term effects for Hungary
AT DE FR GB IT PL
Yd Yf ER Yd Yf ER Yd Yf ER Yd Yf ER Yd Yf ER Yd Yf ER
TT
2.41 -7.37 8.89 -0.63 0.91 -0.09 -10.60 9.13 -1.11 -0.52 1.44 -0.17 -2.58 8.13 -1.18 0.16 -0.49 1.75
T0
x x x 1.84 1.49 -4.42 6.18 -4.86 7.19 -11.44 1.23 -2.69 6.42 1.04 -1.11 0.10 1.42
T1
1.48 -2.06 2.94 2.74 8.26 -0.24 -6.65 2.07 0.05 x x x -5.58 10.37 1.19 -1.91 3.01 -1.50
T2
-0.96 4.56 -0.19 x x x x x x x x x 0.42 -0.24 1.89 1.46 -1.50
T3
2.99 -10.32 9.13 x x x x x x x x x x x x x x x
T4
x x x 3.62 4.19 x x x x x x x x x x x x
T5
-0.00 -0.66 2.79 -2.89 1.12 -0.83 -0.30 6.40 -1.14 x x x -0.08 6.76 -0.91 x x x
T6
-0.14 -1.86 0.73 -4.65 12.81 1.86 2.14 -5.67 0.79 x x x -0.98 1.23 -0.12 0.08 0.89
T7
x x x 0.17 0.47 -7.70 4.94 -1.64 -1.17 2.27 -0.39 2.20 -1.91 -2.10 1.78
T8
0.24 -2.24 0.29 -2.32 2.34 -2.84 6.18 2.23 -2.07 8.61 4.60 -1.75 x x x -0.47 0.04
T9
x x x x x x x x x x x x x x x x x x
Source: Author's calculations
51
The assumption of the negative impact of domestic GDP growth on the export to
import ratio can be clearly confirmed for Hungary’s tested trade balances neither
(Table 6). This fact is evident in the estimated positive coefficients for the third and
fifth most important trading partners - AT and PL. The highest degree of conformity
of results in terms of territorial distribution is confirmed for FR, where the expected
effect can be observed at bilateral level and at the 76% share of the total partial
trade balances. On the other hand, significantly different results between the
bilateral-level and product-level analyses are seen in trade balance with PL. At the
product level, we can see the uniformity of results in product category of chemicals
and related products. These products represent 9% of the total foreign trade of
Hungary and an 11% average share of bilateral trade flows examined.
The expected positive effect of GDPs growth in trading partners’ economies is clearly
demonstrated in trade balance with the major trading partner - DE. German
economic growth probably translates into increased demand for Hungarian products,
and thus leads to an improvement of the individual commodity trade balances. The
same direction of effects is also reflected in trade with FR, except the product
category with machinery and transport equipment (9% of bilateral trade). Although
the trade balances with the GB show a tendency for long-term joint motion only in a
minor number of product categories, increasing of its GDP would be linked to the
improvement in the ratio of Hungarian more than 74% share of their bilateral trade.
Parameter shows considerable inconsistency between product and bilateral analyzes
and points to a bias resulting from the aggregation of data also in the case of PL.
Although the results of the analysis indicate that the growth of Austrian GDP probably
does not lead to an improvement in the trade balance with AT, the improvement can
be led by the depreciation of the Hungarian forint against the euro. This depreciation
seems to be an effective tool even in the case of improvement of product trade
balances that cumulated represent an 80% of trade with DE on one hand, but only
33% of trade with IT and 12% of trade with FR on the other hand. The results of the
paper suggest that an increase in the ratio of exports over imports with the PL can be
reached through the depreciation of the Hungarian forint against the Polish zloty in
both - total bilateral as well as product categories representing 77% of their mutual
trade flows. Long-term effects analysis further showed that the depreciation of the
Hungarian forint is associated with improvement in all trade balances of machinery
and transport equipment (13% of the total Hungarian foreign trade).
Table 7 shows that even Poland’s GDP (as the domestic one) does not have the same
effects on the individual bilateral trade flows. The trade with CZ, GB and IT manifests
that an increase in the domestic GDP is linked to an increase in the value of the
relevant international commodity transactions, but at the same time in trade with DE,
FR and SK we do find the expected negative coefficient of estimation. Cointegrated
partial trade balances with the GB support conclusions from the analysis at the
overall bilateral level. In other cases, the results are mixed, and show the differences
in the structure of trade flows and within individual product categories.
The parameter of foreign GDP again offers a little bit clearer conclusions. The
theoretical assumptions of positive effects of foreign GDP on trade balance are not
52
met in the case of GB. Other estimates support the theory of approximation of GDP
to foreign demand for domestic goods and lead to an increased Polish exports. The
overall bilateral effect of foreign GDP is supported by product categories with share in
the bilateral foreign trade from 55% for DE up to 91% for FR. Cointegrated productlevel
trade balances with SK fully correspond to the bilateral estimate.
Table 7 Estimated coefficients of long-term effects for Poland
CZ DE FR GB IT SK
Yd Yf ER Yd Yf ER Yd Yf ER Yd Yf ER Yd Yf ER Yd Yf ER
TT 0.55 0.17 0.32 -0.24 0.23 0.39 -0.15 1.49 0.57 3.65 -2.77 1.01 5.49 8.94 2.47 -1.24 0.34 0.13
T0 -0.23 0.87 0.73 0.40 -4.96 0.53 x x x x x x 0.60 2.43 -1.21 x x x
T1 -0.34 2.18 -1.51 0.22 1.55 0.82 8.13 -5.61 0.13 x x x 0.24 4.51 1.35 -0.92 0.84 -2.59
T2 3.08 -4.26 0.21 -2.10 3.64 -0.71 x x x 0.29 4.39 1.03 6.23 1.51 0.77 x x x
T3 -0.41 0.38 0.57 -1.73 0.65 028 x x x x x x x x x x x x
T4 x x x x x x x x x x x x x x x x x x
T5 1.80 -1.52 0.34 2.03 0.44 5.98 2.73 x x x 10.04 -1.86 -2.31 7.44 2.79 0.72
T6 1.25 -0.77 0.62 -0.61 1.16 -0.01 -0.95 4.02 -0.85 2.83 0.34 2.12 1.33 1.73 0.34 -1.40 3.94 3.68
T7 -1.47 2.71 -0.74 1.10 -3.71 1.61 3.03 5.90 -1.05 3.33 -3.74 3.58 0.52 1.31 1.35 -0.09 0.81 0.24
T8 0.14 -0.67 2.23 -1.91 2.05 -0.98 -4.02 10.13 -1.75 5.78 -1.20 0.84 -0.70 3.64 1.79 -3.18 3.07 2.71
T9 x x x x x x x x x x x x x x x x x x
Source: Author's calculations
The results of the paper show that the depreciation of the Polish zloty is associated
with an improvement in bilateral trade balances with the countries analyzed. The
highest coefficient of this effect was estimated for IT. Also the positive effect of
PLN/GBP increase on the trade balance with GB is proved. Such a change leads to the
substitution of products with cheaper Polish ones, to an increase in consumption
caused by reduced prices expressed in GBP, possibly to a reduction of the volume of
goods imported from GB as a consequence of increased prices expressed in PLN.
Although the depreciation of the Polish zloty against the euro is associated with an
increase in bilateral trade balances of all partners analyzed from the euro area, the
estimates for territorial and commodity-territorial are not consistent again. Links
between the PLN/EUR exchange rate and trade balance suggest improvement in the
ratio of export to import in product categories representing 59% of trade with DE and
only 17% with FR. Although the depreciation of the Polish zloty against CZK
demonstrates a positive effect on product-level trade balances representing 60% of
the total foreign trade with CZ, the results again confirm the problem of smoothing
out of effects after aggregating data of different kinds of goods.
The analysis of long-term coefficients for the trade balance of Slovakia failed to
assess the clear ties to its GDP. This conclusion is valid for both - bilateral and
commodity level. Trade with AT, FR and HU represents a 14% average share of its
53
total foreign trade, which is associated with an increase in trade balance after
Slovakia’s GDP growth. In contrast, trade flows, representing 40% of total trade,
support the assumption of the primary impact of growth in domestic GDP on imports
and hence the overall deterioration in the trade balance. Cointegration analysis at the
product level corresponds largely with the bilateral analysis. The estimated
coefficients in the case of PL differ between the analysis only in trade with beverages
and tobacco, which represents less than one percent of their bilateral trade, in other
analyzed models, this share ranges from 15 to 19%.
Table 8 Estimated coefficients of long-term effects for Slovakia
AT CZ DE FR HU PL
Yd Yf ER Yd Yf ER Yd Yf ER Yd Yf ER Yd Yf ER Yd Yf ER
TT 1.13 2.27 -1.14 -2.76 3.08 0.12 -0.56 4.12 0.55 0.07 -0.17 0.34 0.52 1.27 -0.14 -1.07 2.18 0.12
T0 -0.40 -0.46 -0.32 -1.15 1.27 -0.90 -0.70 2.32 0.22 -2.97 -1.05 -5.63 0.29 -0.87 3.56 -0.45
T1 -0.12 1.80 0.85 -0.73 3.12 0.42 1.33 1.43 -0.27 0.89 1.42 0.34 3.47 -0.09 -0.04 1.44 2.98 0.92
T2 0.07 -0.05 0.11 -2.96 -0.09 1.01 1.09 -0.98 -0.18 1.14 0.94 -0.22 -1.09 1.24 1.08 -3.76 -2.59 0.51
T3 x x x 0.61 0.54 0.12 -0.45 1.08 0.98 -0.98 0.63 0.03 -3.44 2.32 1.67 -3.08 -1.29 -0.07
T4 x x x x x x x x x x x x X x x x x x
T5 -0.49 2.98 -0.82 -1.14 -0.05 0.19 1.03 3.26 -0.76 -2.23 -0.87 0.86 -0.88 -0.89 0.01 -4.01 2.25 -0.67
T6 x x x -0.07 1.39 0.88 -0.70 -0.09 1.03 x x x 1.08 3.01 -0.54 -0.05 0.25
T7 3.05 1.15 -0.32 5.23 0.36 -1.28 2.95 0.50 3.02 2.09 1.01 3.90 1.84 0.93 1.34 0.18
T8 -0.43 1.25 0.47 1.04 2.28 -0.03 -2.02 5.06 1.05 -1.12 3.61 0.13 1.05 1.18 1.76 0.63 1.76 0.04
T9 x x x x x x x x x x x x X x x x x x
Source: Author's calculations
Clearer conclusions can be formulated in the case of foreign GDP for Slovakia as well.
The theoretical assumption of direct relationship was not confirmed only for FR at the
bilateral level. FR has the lowest share among Slovakia’s analyzed trading partners.
The inconsistency between bilateral and product-level analysis ranges from 9% to
29%.
The results presented in Table 8 show a direct link between the exchange rate in
direct quotation and bilateral trade balance with CZ, DE, FR and PL. Their average
share in total foreign trade of Slovakia is 44% in the sample period. These results
thus suggest that joining the euro area means a loss of one of the effective tools to
adjust the trade balance. However, it is necessary to highlight the limitations of this
analysis given by the shortened time series for AT, DE and FR resulting from the EUR
adoption as the official currency of Slovakia and the revaluation of the central rate of
SKK/EUR during Slovakia's participation in ERM II.
54
2.3 Discussion of the Results
The lag analysis showed that delay of the effects of tested variables is on average
higher for manufactured goods, machinery, transport equipment and miscellaneous
manufactured articles. In these sectors we suppose the existence of longer delays
caused by the existence of more long-term contracts and also time-consuming
production. This means that these product categories respond after a longer period
than other internationally traded goods. Although the number of cointegrated
product-level trade balances is lower in some cases, the dominance in traded goods
with a tendency to the long-term equilibrium can be observed. Based on this analysis
it can be stated that the most of total bilateral and product-level trade balances are
characterized by long-term joint motion with the development of domestic and
foreign gross domestic product and a bilateral exchange rate, although the direction
of their action is not always in line with the theoretical assumptions. The results of
this work thus correspond to the findings of the studies by Šimáková (2012a, 2012b,
2014).
The analysis conducted further shows a long-term relationship between the exchange
rate and foreign trade of V4 countries at the bilateral level in all tested trade balances
with the exception of trade between Poland and Great Britain. As regards commodity
distribution, a common feature of no long-term relationships between exchange rates
and trade balances with animal and vegetable oils, fats, waxes and inconsistent
product group of goods can be isolated, which due to their nature are not included in
the other test categories and do not have any common characteristics. Inconsistency
between bilateral and product-level results confirms the assumed bias resulting from
the data aggregation. Diversity of effects of foreign exchange rates observed at the
aggregate, bilateral and commodity levels is also confirmed in studies by Breuer and
Clements (2003), Bahmani-Oskooee and Ardalani (2006), Baek (2006), BahmaniOskooee
and Wang (2007) and Bahmani-Oskooee and Mitra (2008).
The findings of this paper show in some ways disunity with economic theory and
cannot be clearly generalized across the countries or product categories analyzed.
The ambiguous exchange rate effect on V4 foreign trade can be explained by several
characteristics of interaction of these economies with the international commodity
movements. V4 countries have import-intensive exports, significant presence of
foreign direct investment. Many foreign companies with subsidiary branches in
countries surveyed include multinational corporations operating in different
territories. This fact implies their strong involvement in export and import
transactions within multinational companies. Kiss and Schuszter (2014) also discuss
the implications of corporate financing through loans in foreign currencies. All these
attributes result in the fact that the bulk of international trade is related to the
natural hedging. Čadek et al. (2011) performed an analysis of hedging in the case of
Czech companies and found that the majority of exports are realized through the
euro. Similar conclusions can also be found for the other V4 countries in the study by
Égert-Zumaquera and Morales (2008). An important factor in the characteristics of
foreign trade V4 is the degree of integration of trading partners. According to
Martinez-Zarzoso and Ramos (2008), with the higher integration of economies, the
volume of trade between them is increasing and exchange rates as one of the
55
determinants act to a lower extent. V4 clearly show the importance of integrity for
the implementation of foreign trade and for trade within the EU.
Conclusions
The paper deals with the relationship between exchange rates and foreign trade. The
aim of this paper was to reveal the long-term effects of the level of exchange rates
on the trade balances of the Visegrad Countries. Analysis is based on the assumption
that different product categories are characterized by different price elasticity of
traded goods and exchange rate development faces risk aversion to various degrees
in every country. There are entities with a variety of consumer and producer behavior
patterns. Hence, the paper contributes to the economic studies dealing with the postcommunist
countries which are fully transformed into a market economy by the use
of relatively new territorial-commodity approach. Because the paper represents a
study focusing on V4 and employs disaggregated product-level data of bilateral trade
with the largest trading partners, the greatest contribution of this study is its more
detailed results. The territorial and commodity approach applied also helps to reduce
distortion caused by the aggregation bias.
The analysis performed shows a long-term relationship between the exchange rate
and foreign trade of V4 countries at a bilateral level in all cases, except the trade
between Poland and Great Britain. This fact is probably caused by the diversity of
structures of their economies. Results for other trade flows thus support the claims of
long-term trend towards the mutual development of the V4 bilateral trade balances
and their level of exchange rates. Product-level analysis pursues a common feature of
no long-term relationships in the case of trade balance with animal and vegetable
oils, fats, waxes and inconsistent product groups of commodities and transactions not
classified elsewhere in the SITC, which due to their nature cannot be included in
other tested categories. Hence, this kind of group does not show the common
characteristic features of behavior. The lag structure differs more across different
product categories than across different trading partners. In general, higher lags are
typical for groups of manufactured goods, machinery and transport equipment and
miscellaneous manufactured articles. These categories of goods are supposed to be
purchased under long-term contracts, and it usually takes more time to adapt to new
price conditions. Although there are some product categories without proved
cointegration, the product categories tending to the long-term equilibrium
significantly exceed them. Based on this analysis it can be stated that the bulk of the
total and partial bilateral trade balances are characterized by a common long-term
development with domestic and foreign GDP and bilateral exchange rates.
In summary, the results based on disaggregated data clearly demonstrate that the
role and effect of exchange rates on V4 foreign trade are not definite. Although there
are clearly demonstrated links between exchange rate and foreign trade, one cannot
simply assume that the depreciation of domestic currency will boost exports, reduce
imports and, hence, improve the trade balance. This conclusion can be associated
with the fact that V4 exporters and importers intensively hedge their foreign trade
activities, V4 exports are significantly dependent on imports, and V4 companies are
largely owned by foreign investors and belong to multinational corporations.
56
Therefore, product groups and trading partners should be carefully distinguished
when considering exchange rate effects on foreign trade.
The use of product-level data also allows the identification of sectors that are more
affected by the exchange rates. This approach enables to isolate the specific effects
of exchange rate development on specific trade flows. This practical benefit of the
paper for the corporate sector is based on a demonstration of the need to
differentiate the regional characteristics of the markets where they could place their
production as well as the types of products that will be held for trading in selected
foreign markets. The results obtained can be further taken into account by national
central banks of each country in assessing the potential impact of the current
exchange rate policy. Conclusions can also be used in the development of targeted
policies to promote foreign trade of specific products through foreign exchange
interventions on the domestic currency. The findings demonstrate that steps of their
central banks towards the stability of the exchange rate could reflect in increasing of
the total turnover of internationally traded goods.
Acknowledgments
Publication of this paper was supported by the Ministry of Education, Youth and
Sports within the Institutional Support for Long-term Development of a Research
Organization in 2016. The support is gratefully acknowledged.
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