Table of Contents
Chapter One. 4
Research Background. 5
Research Objectives. 5
Research Questions. 6
Chapter Two. 6
Literature Review.. 6
Demand and Supply of Oil 9
Changes in OPEC Objectives. 10
Geopolitical Developments. 10
Appreciation of the Dollar. 11
UAE Government Spending. 11
UAE Oil Sector Performance. 12
Financial Implications of the Oil Slump. 12
Oil Slump and Macroeconomic Implications. 13
Gross Domestic Product (GDP). 14
Government Spending. 15
Development in the Financial Market. 16
Employment in UAE.. 17
Sectoral Developments and Diversification. 18
Chapter Three. 18
Research Design. 19
Data and Sources. 20
Techniques of Data Collection. 20
Data Analysis. 20
Chapter Four. 21
Findings, Discussion, and Conclusion. 21
Price Volatility. 23
The price volatility of the model was 0.24877 (24.877%). Generally, price volatility refers to the rate of change in price of a commodity. Therefore, the higher the price volatility, the greater the rate of change in price of a commodity. Since Brent oil has a high price volatility at 24.877%, it indicates that the rate of increase or decrease in price of oil is high and sporadic. The price volatility was calculated using the annual standard deviation of oil. Since the price of Brent oil was classified annually, there was not need of multiplying it with the square root of number of days to get the annual price volatility. The standard deviation was actually the price volatility (See excel file). 23
Johansen Cointegration. 23
Vector Error Correction Model 24
Short run causality. 24
Reference List. 26
Oil Price Volatility Over the Period 2007-2016 and Implications to the UAE Economy
Oil price volatility is a global problem or opportunity depending on a countries relationship with the oil market. As for oil producing countries, such as UAE, the plunge in oil prices has had catastrophic effects on their economic performance. On the contrary, oil-importing countries have enjoyed the decline in oil prices, which has made them save most of their foreign exchange. Intermittently, in 2008 and mid-2014, the global economy continued to witness a sharp decline in oil prices. This trend has resulted in the distribution of incomes, and even a change in the consumer pattern. In UAE, this trend has been vivid in the housing market, where citizens from non-oil producing countries such as India, China, and Pakistan have overtaken those from oil producing nations as the main homebuyers. Given that the economy of oil producing countries is dependent on oil revenue, which is dependent on both oil prices and output, as well as other economic subsectors that are interconnected with the oil industry, a fall in the price of oil has a compounding effect in these countries (Benes et al. 2012). In fact, despite the diversified economy of Dubai, far off industries such as the housing market have been affected by the decline in oil prices.
UAE is highly dependent oil, a factor that has resulted in the country making purposeful efforts to diversify its economy. UAE is the 7th largest oil producer. It has extensive oil reserves of nearly 100 billion of confirmed oil barrels. In addition, the country has a low marginal cost of production at only $7 per barrel. Specifically, these favorable conditions have made the country to be dependent on oil. In 2014, the oil sector rents contributed 19% to the country’s GDP. 36.8% of the country’s exports consisted of oil and as much as 35% of the country’s pre-tax budget was from oil. As a result, the country is highly fragile to events of oil shocks. Impliedly, a downward pressure on the oil prices will reduce the country’s revenues and in turn GDP.
The oil price experienced a rapid growth from $30 per barrel in 2004 to a high of $140 per barrel in 2007, which was mainly boosted by the rapid growth in demand from fast-growing economies in Asia and beyond. In 2008, there was a small shock in the oil market, which made the oil prices to fall but returned to a stable price of between $100 and $120 for about 3 years. In January of mid-2014, the oil prices plummeted to a minimum $26 (Kitous et al. 3).
Many researchers have studied the relationship between oil price and major macroeconomic indicators such as real GDP, government revenues, consumption, and expenditures. Their studies have confirmed that a decrease in oil prices will raise the real GDP in oil-importing countries. On the contrary, it will result it will result to a fall in GDP in oil exporting economies. The same relationships are observed between oil prices and government revenues and spending. Yet, research works mostly generalize the said relationships and analyze them in groups of countries rather than individually. Therefore, the objective of the current research is to examine the relationship between oil prices and their effects n GDP, government revenues, and expenditures in UAE. In particular, this research examines on whether oil price volatility can explain about the slowdown of the UAE economy.
- What is the oil sector performance and its contribution to the GDP of the UAE?
- What are the financial and macroeconomic consequences for the UAE economy from oil price plunge?
- Are oil prices correlated with GDP and government spending?
- How does the fall in oil prices change the government spending in various sectors of the UAE economy?
- What are planned diversification programs for the UAE, and what are their possible impacts on the country’s overall economic performance?
The theoretical framework and analysis of collected data will assist in testing of two hypothesis:
H1: A fall in oil prices will slow down the GDP growth in the UAE economy.
H2: A fall in oil prices will not slow the GDP growth of the UAE economy.
Although UAE is the most diversified economy in the Gulf Cooperative Council (GCC), its economy is still heavily reliant on oil revenues. Given the persistent decline in oil from 2014, this paper will investigate the impact of oil price volatility from 2007, with most attention on UAE’s economy. The current price in oil marks the end of the commodity supercycle, which began in the early 2000s (Baffes et al. 2015). Although there has been a sharp drop in oil prices in 2014, this drop is not unprecedented. Similar oil crisis such as the 1985-1986 crisis, the 1990-1991 crisis, the 2000 crisis, the 1997-1998 crisis, and the 2008-2009 crisis have occurred before.
Largely driven by heightened demand in emerging economies and various commodities markets, the supercycle brought a double-digit annual inflation-adjusted price increase of oil from 2000 until the 2008 financial crisis 2. However, this growth was brought to a sudden halt by the 2008-2009 financial crisis. In the 2014-2015 period, oil prices dipped with as much as 30% from their previous high rates. This latest fall in oil price has significant parallelism with the price collapse of 1985-1986.
The 1985-986 oil crisis occurred after the expansion in supply from non-OPEC countries as well as the eventual decision of OPEC to increase production and not to use price targeting (World Bank, 2009). The current plunge in oil prices is due to various factors, key among them are the weakened global demand for oil, the emergence of geopolitical risks, the appreciation of the dollar, a change in OPEC’s policy, and the continued increase in the production of unconventional oil. Among the various causes of the oil plunge, the decision by OPEC in late November 2015 not to curtail production is thought to have resulted in the largest decline in prices. The IMF 2015, noted that this decision led to a 20% fall in price because markets changed their expectations on the future of OPEC’s supply.
The unexpected changes in global oil production were mainly due to the emergence of the USA shale oil as a major contributor to the global supply. EIA notes that the US field production of oil increased by 67% during the 2011 to 2015 period. In effect, US became the largest producer and consumer of oil, surpassing Saudi Arabia and Russia. Similarly, the higher than expected production of oil from Iraq, Libya, and Saudi Arabia in 2014 contributed to the plunge in oil prices. In particular, Saudi Arabia abandoned its role as a swing producer in November 2014, and in turn maintained it production above 20% the 2011 levels.
The 2008-2009 oil prices differed from the 2014 to present oil crisis in that the latter’s crisis was due to sectoral factors while the former was due to the collapse in the oil demand as a result of the global financial crisis and uncertainty, which led to a global liquidity crisis. Further, in the 2008-2009 oil crisis, the global equity returns were more correlated with the daily oil price changes than in the 2014 to date oil crisis.
The decline in oil prices may lead to a wide change in real income from oil exporters to importers, which is likely to result in an overall net gain for the global economy in the medium term. Baffes et al. 2015, opine that a 45% decline in oil prices is associated with a 0.7-0.8% increase in global GDP in the medium term and a 1% temporary decline in global inflation in the short term. Generally, a decline in oil prices leads to an increase in disposable income in oil importing countries since it has similar effects with a tax cut. The positive impact among oil importers is more diffuse and takes some time to materialize. On the contrary, the negative impact is immediate and accentuated by financial market pressures on the exporters’ side.
The fall in oil prices may result in various macroeconomic conditions depending on a country’s economic interactions. The plunge in oil prices has resulted in the reduction in the cost of living in oil-importing countries. A similar situation occurs in factories that depend on oil in the manufacturing process since they enjoy a reduction in the cost of manufacturing. As a consequence, the role in the transmission of the fall in oil prices in relation to real incomes depends on the magnitude of the oil decline and the price that users pay.
The nature of the oil price is a critical indicator of the expected changes in the global market caused by the oil shock. Low oil prices may be a shock in response to other shocks that may be driving the global economy. For instance, a decline in global oil demand due to technological changes may have spillover effects on various economies. Overproduction of oil is another underlying factor, which can affect its price due to cases of excess supply.
Persistence of fall in oil prices is another factor that may affect the performance of oil producing countries. If permanent, these nations would have to adjust their spending habits. Therefore, the persistence in the fall in oil prices will depend on the underlying drivers. Although technological progress normally results in a shift in oil supply, which may result in permanent price changes, feedback effects such as increased oil explorations may offset these gains.
Although changes in the demand and supply conditions determine the long-run trend in prices, in the short-run, changes in the market sentiments and expectations lead to the fluctuation of prices. According to Beffes 12, the recent crisis is unique since it coincides three major developments, receding geopolitical risks, an appreciation of the US dollar and a shift in OPEC’s objectives. In particular, these conditions reinforce and affect the long-term shift in supply and demand for oil.
Benes et al. 2012, notes that the current oil markets have been affected by greater than anticipated rise in supply. The Canadian oil sands and the US shale oil are some of the main contributors. The Bank of Canada 2015, notes that if the current oil prices remain below $60 per barrel about a third of current oil production and two-thirds of expected increase in global oil production would become uneconomical. IEA 2014, notes that the favorable financing the post-2009 oil crisis made shale oil extraction profitable. Further, since shale oil extraction has a short life cycle of 2.5 to 3 years from the start of development to extraction, it is more elastic to price changes (Benes et al. 2012). Therefore, when there is access to favorable financing, a rise in oil price can be followed by a quick increase in shale oil production.
Since 2012, the oil demand forecast has been continuously downgraded due to a slowdown in large emerging economies. Emerging economies are more oil intensive than developed countries. Therefore, an increase in their rate of development normally has a corresponding high rise in the oil demand forecast. Fournier, Koske and Wanner 2010 opine that a 1% increase in the GDP of OECD member countries raises the oil estimates by 0.5% while there is a rise of 1% if non-OECD countries have a similar rise in their GDP.
With the emergence of unconventional oil production such as Shale oil and Canadian sands, OPEC’s share of global oil has been eroded. In effect, OPEC has abandoned its previous policy of target pricing in order to control the market (OPEC, 2015). According to Kaletsky 2015, the marginal costs of the unconventional oil producers will from now be used to set the market price.
Given that the oil fluctuations are dependent on speculations besides changes in demand and supply, recent events in the world’s geopolitics have resulted in the fluctuations. According to the IEA 2014, the market weight of the war in Iraq due to ISIS did not have as much impact on oil production as anticipated. Similarly, the sanctions imposed on Russia did not have a significant impact on Europe’s oil market. Consequently, the oil prices failed to recover to their former 2013 prices.
Between 2014 and 2015 the US dollar appreciated by more than 10% against most currencies in trade-weighted nominal terms. Effectively, this appreciation led to an increase in the cost of importing oil in non-oil producing countries, in turn, the increased cost led to a decline in demand. Zhang et al. 2008, estimate that a 10% appreciation in the dollar leads to 3-10% decline in oil price.
According to Aggarwal 2014, the UAE government has reduced subsidies for services such as electricity and water in response to the slowdown in economic recovery. Harald, notes that the UAE has been reducing its budget in order to balance its budget. Abu Dhabi government has also been reducing its water and electricity budget to mitigate against risks of fluctuating oil prices.
According to the IMF 2015, the UAE has tremendously increased its general spending and expenditure from 2000 to 2014 in real terms. The hydrocarbon total revenue grew by 11% from 2000 to 2014, which resulted in the government increasing its total expenditure by about 10% during this period. The UAE normally experiences a pro-cyclical spending culture to its oil prices. However, in 2008-2009, it was countercyclical due to the global financial crisis that made the government support local demand.
According to the World Trade Organization (WTO) 2016, UAE was expected to reduce its 2015 expenditure by 0.9% as compared to 2014. The major reason for this decline was due to the decline in government subsidies and grants. The main expenses in the UAE were subsidies, provision of social protection, and the support for industries. In 2014, on-budget subsidies were 2% of the country’s budget expenditure. However, the total (implicit) energy subsidies were about 5.7% of the country’s 2011 budget.
Declining oil performance has taken a toll on many economies. Since December 2014, the price per barrel of Western Texas crude oil dropped from over $100 to less than $60 a barrel. The Brent crude followed suit and prices slid to below $45 a barrel in 2015. According to the IMF 2015, the oil and gas sector contributed 24% of the UAEs GDP in 2014, up from 18 percent in 2004. Further, it accounted for 65% of the government’s total general revenue in 2014. The nonhydrocarbon revenue excluding investment income from the sovereign wealth fund (SWF) increased to 8% of the GDP from 2009 to 2015, as compared with between 4 and 5% in 2004-2008 period. The investment income from SWF contributed to about 5% of the country’s 2014 GDP. The nonhydrocarbon revenue excluding investment income accounted for 20 percent of the total revenue, which was 8% of the country’s GDP.
Currently, the UAE has accumulated ample sovereign assets from oil revenues, which it has used to set up various SWFs. The overarching need for these SWFs is to diversify the UAE economy, to ensure there is the intergenerational saving transfer, to invest in social priorities, and for fiscal stabilization of the economy. The country’s total SWFs were about $1200 billion by the end of 2015. Most of its SWFs, which are held mostly in Abu Dhabi focus on long-term financial returns and sustained economic growth (Iyigun, 2015).
The Dirham has appreciated by 29% since 2000 in real effective terms. The appreciation of the Dirham is mainly due to the US dollar movements on the Euro. From 2005 to 2012, changes in the real effective exchange rate (REER) were mostly due to inflationary pressures, which offset the Dollar vis-a-vis the Euro. As from 2005 to 2012, the country’s inflation was in line with that of its trading partners. Similarly, the REER appreciated by 17.8%, in line with the changes in the US dollar strength. As of 2016, the REER depreciated due to a similar depreciation of the dollar as well as low inflation rates (Samba 2016). Despite the increase in the value of the Dirham and REER, UAE has continued to enjoy huge economic trade. For instance, the tourism sector more than tripled between 2000 and 2015. Similarly, the nonhydrocarbon exports increased from 20-66 percent in the same period (Husain et al. 2015).
The GCC countries have become major economic powers due to their tremendous economic growth during the period of the oil boom. They now attract huge foreign capital due to their attractive business environment, which has low taxes and highly developed infrastructure. The Gulf market, which has a GDP of $1.6 trillion, is a robust and vibrant market that is able to attract foreign direct investment (WTO 2016).
The international trade between Gulf countries and the rest of the world recorded $95 billion by end of 2013. As at 2015, these figures were estimated to be $146. The region also enjoyed a trade surplus during the 2013 financial year. The region’s total exports were $921 billion while the imports were $514 billion. The inflation rates as at June 2015 were 4.22% in UAE. The food and beverage group rose by 1.44% in June 2015 when compared to the same period in 2014. There was a 10.21% rise in the housing, water, electricity, gas and other fuel between 2015 and 2014 (Samba 2016). The transportation cost rose by 0.38% between 2014 and 2015. The water, electricity and other fuels had the highest rise in cost as 10.21% during the same period. On the other hand, the clothing and footwear group had the highest decline at 3.35%.
The inflation index for 2014 was 120.84, while it was 118.07 in 2013. Therefore, there was a rise by 2.33% in the overall inflation rates in the country. In 2015, the consumer price index rose by 4.31 percent when compared with these figures in 2014. The month-to-month price increase for the period was 0.9%. According to the National Bureau of Statistics, UAE’s inflation rose by 21% over the past seven years from 207 to 2014 (United Arab Emirates Ministry of Economics 2016).
As at 2014, data from the National Bureau of Statistics showed that the GDP estimated were 1.46 trillion dirham, which was an increase by $ 45 billion dirhams from 2013 figures. Therefore, there was an overall growth rate of 3.2%. Despite the shocks in oil prices from 2009, the country’s GDP has maintained an upward growth rate. The GDP estimates from non-oil sectors amounted to 963 billion dirhams as at 2014. This figure was an 8.1% increase from the 2013 results of 890.9 billion dirhams. Noteworthy, the country’s GDP in the non-financial projects sector was 1.33 trillion dirham in 2014. This rise represented a 2.1% increase from the 2013 figures. As a result, it comprised 90.7% of the country’s GDP (United Arab Emirates Ministry of Economics 2016).
Activities related to the extraction of crude oil and natural gas contributed 34.3% of the GDP. The wholesale, retail trade activities and repair services contributed 11.3%. The real estate market contributed 10.3%. A similar production output was observed in the business services sector. The construction and the mining industry both accounted for 9% of the GDP. The country’s overall GDP rose to a high of 1.15 trillion dirhams in 2014 from 1.1 trillion dirhams in 2013. The value of GDP in the non-financial sector was 1 trillion dirham, which was approximately 90.5% of the country’s total GDP. 31.7% of the total was GDP, which was 366 billion dirham, was from the oil and natural gas sector (WTO 2016). The gross fixed capital formation was 347 billion in 2014, which had increased from 321 billion dirhams in 2013.
In order to maintain the consumer spending, the UAE has adopted reversal policies to cope with the downturn in oil prices. In particular, these policies aim at increasing the consumer demand levels to stimulate economic growth in both the short term and the long term. In 2014, the size of the real consumer spending rose by 0.3%, from 576.6 billion dirhams in 2013 to 578.3 billion dirhams in 2014. However, due to the higher increase in the rate of GDP than that of consumption, the proportion of consumption in relation to GDP dropped to 50.1% from 52.2% in 2013 (WTO 2016).
In an effort to diversify its economy and ensure it is able to cope with shocks brought about by a decline in oil prices, the country has continued to pursue expansionary policies by investing in strategic economic sectors. Specifically, the country has invested heavily in transportation, energy, tourism facilities, e-logistics, financial services, and e-infrastructure as well as in education and research. In particular, the development of a knowledge-based economy will enable the country to diversify into other non-oil dependent industries.
Between 2014 and 2013, the government’s total investments rose from 321.6 billion dirhams to 347.9 billion dirhams. This increase resulted in an 8.2% rise in total investments. The value of government contribution to private investments increased from 190.2 billion dirhams in 2013 to 201.8 billion dirhams in 2014, which was a growth of 6.2%. The share of the government and public sector in the implementation of investments increased to 146 billion dirhams in 2014 from 131.4 billion dirhams in 2013, which was an 11.1% growth (WTO 2016).
Foreign Direct Investments and Diversification
According to the 2015 United Nations Conference on Trade and Development (UNCTAD), the UAE attracted 37.07 billion dirhams ($10.1 billion) of foreign direct investments (FDI) in 2014, with an average growth rate of 16.4% for the 2010 to 2014 period (UNCTAD 2015). The cumulative FDI during the period was 424.3 billion dirhams. The outward investments from the UAE in 2014 were 11.3 billion dirhams, which was slightly higher than the 10.8 billion dirhams invested in 2013. The cumulative total investments were 66.3 billion dollars as at the end of 2014, compared to $63.2 billion in 2013, and $1.9 billion in 2000 (WTO 2016).
The UAE is an attractive destination for global foreign direct investments, especially in the tourism, recreational, infrastructure, renewable energy, real estate sector, and finance. In particular, the country’s political stability has enabled foreign investors to venture into various business opportunities in the country. In addition, the regions diversification of income sources, sound economic policies, and a shift to a knowledge-based economy has enabled UAE to attract global companies. In addition, various complementing infrastructures such as the Etihad Airlines, which is spread in the entire Emirates, the railway network, and the country’s distinguished location as a crossroad for global trade routes makes it a favorable investment destination.
In 2014, the sharp decline in the oil market resulted in a decline in the country’s capital markets. At the end of 2014, the Abu Dhabi securities exchange was at 4529 points, while in 2013 it was at 4290 points. The 2014 figures represented a 6% rise when compared to the 2013 figures. On a similar note, the Dubai financial markets rose by 12% from 3774 points to 3370 points by the end of 2013. The number of companies listed in the State’s stock market increased from 120 in 2013 to 125 in 2014. The general index of securities prices in the two-year increased from 4313.6 points to 4580.1 points. This increase was a growth rate of 6.2%, and the market value of traded shares increased from 646.3 billion dirhams in 2013 to 728.4 billion dirhams in 2014. This increase was a 12.7% growth rate of the floated shares.
According to WTO 2016, the UAE population increased by 3% from 9.3 million in 2014 to 9.58 million in 2015. In the last ten years, the region has had a cumulative growth rate of 8.8%, mostly due to its thriving economy. As at the end of 2013, the rate of participation in the labor force was 80% of all individuals who were over 15 years. The country’s unemployment rate during this period was 3.8%, a decline by 0.2% from the 2012 figures, which were 4%. In 2014, the unemployment rate fell to about 3.6% (WTO 2016). In 2013, the male unemployment rate was 2.8% while female unemployment was 8.8%. The general drop in unemployment rates despite the country’s population increase indicates measures by the government to create jobs for its citizens.
In the sectoral distribution of employees, in year 2013, 4.3% were in the agriculture, animal resources, and fisheries sector, 1.1% were in crude and natural oil sector, and 0.2% were in quarrying. 11.6% were in manufacturing, 1.1% were in electricity and gas, 19.5% were in construction and building, and 19.1% were in wholesale and trade. Further, 5.0% were employed in restaurants and hotels, 7.3% were in transport, storage, and other communication, 0.2% were in communications, and 3.9% were in real estate and business services. Finally, 4% were in social and personal services, 1.6% were in the financial sector projects, 11.5% were in the government services sector, and 9.5% were in home services sector.
The UAE GDP in current estimates grew to $416 billion in 2015 as compared to $ 399 billion in 2014, and $387 billion in 2013. The country’s GDP has grown tremendously. In fact, its current GDP is four times its 2001 size. The country’s GDP growth rates were 3.1% in 2015, 4.6% in 2014, and 4.3% in 2013. The energy sector plays a key role in UAE’s economy. In 2014, the oil and gas sector contributed 33% to the total GDP. The manufacturing sector contributed 9%, the real estate sector contributed 10%, and the finance sector contributed 8% of the GDP. The finance sector has been the fastest growing in UAE. Between 2013 and 214, it grew by 15%. In addition, it doubled its share into the country’s GDP from 4% in 2001 to 8% in 2014. The country’s health sector has been having a high growth rate of about 7% from 2015, which is expected to continue until 2020. The tourism sector also showed robust performance. In 2013, it contributed 56.5 billion dirhams to the economy. It also led to the creation of 495,000 direct and indirect employments. This positive is expected to continue rising with an estimate of 80 billion dirhams in 2024 and creating 626,000 jobs (WTO 2016).
This chapter discusses six subtopics, research design, data and sources, techniques of data collection, and data analysis.
Quantitative method of research has been used in this project. Babbie 2010 notes that when conducting analytical research, numerical data can be generalized and assessed using quantitative analysis in order to find the relationships among various variables. Various analytical methods are used to determine the relationship between oil prices, government investments, and GDP. The Granger causality test, the vector autoregression (VAR), and Johansen co-integration techniques have been found to be effective in determining the relationship between oil, prices, government investments, and GDP.
This project used multiple regression analysis using excel and EViews program to find whether the real GDP of UAE is dependent on changes in oil price, revenues, and government expenditures. The Pearson’s correlation test showed if there was any relationship between the changes in the independent variables and that of the dependent variable. Further, ANOVA test was used in identifying whether the hypothesis in this research was accurate. The lag data consisted of the quarterly data on the oil revenues, government expenditures, and GDP from 2007 to 2015. The Johnasen cointegration test, the Vector auto regression tests, and the WALD coefficient test showed the level of significance of all the variables.
The following two hypothesis were used in this research:
H1: A fall in oil prices will slow down the GDP growth in the UAE economy.
H2: A fall in oil prices will not slow the GDP growth of the UAE economy.
As a result, the research model was as follows:
GDPUAE=K+ X1 PB+ X2RO+ X3GS+ e
GDPUAE= Gross domestic product of UAE
K= Constant, at Y intercept
X1 = Coefficient of price of Brent oil
PB= Price of Brent oil
X2 = Coefficient of total oil revenue in UAE
RO= Total oil revenue in UAE
X3 = Coefficient of government spending in UAE
GS= Government spending in UAE
e = Error/Residual
Statistical data was accessed from the UAE Federal Statistics Authority the World Bank data, OPEC Annual Statistics Bulletins, UAE Central Bank, and the IMF. The data used was from 2007 January until 2015 December. Year 2016 was not included in the research since UAE’s financial budget starts on every October. Therefore, the country 2016 financial year has been in operation for about two months.
This project relied on primary data, which was collected from the UAE Federal Statistics Authority the World Bank data, OPEC Annual Statistics Bulletins, UAE Central Bank, and the IMF. A regression analysis was then tested in order to find if the hypothesis in this research model was correct.
The collected data was then analyzed based on economic theories. Specifically, increased government spending was expected to result in greater economic participation by all individuals in a country, and in effect more GDP. An increase in oil prices was expected to result in more revenue among oil exporting countries, such as UAE. Accordingly, ii was expected to enable the country have more GDP. The analysis of the data was done using the Johansen cointegration test, the ordinary least square test, vector auto regression test (VAR), and the Wald coefficient test.
The research showed that there was a positive correlation of GDP with the price of oil, oil revenue, and government spending. The the correlation for this observation was as shown below:
GDPUAE= 13911.23518 + 773.3403772 PB+ 0.50327966 RO+ 1.951836617 GS+ e
X1 = 773.3403772
X2 = 0.50327966
X3 = 1.951836617
e = Error/Residual value
The regression analysis for this project was as below:
Both EViews and Excel showed a similar regression model which was used to develop the model’s equation (Appendix 12).
In this model, the F- statistic was 34.652 and the f critical was 2.6955. Generally, the model is rejected if the f-statistic is lower than the f-critical. The p-value was also lower than the stated alpha level of 0.05. Therefore, the model was not adequate to represent the factors that affect the UAE GDP. In order to evaluate the accuracy of the ANOVA model, Johansen cointegration and vector error model were used.
The price volatility of the model was 0.24877 (24.877%). Generally, price volatility refers to the rate of change in price of a commodity. Therefore, the higher the price volatility, the greater the rate of change in price of a commodity. Since Brent oil has a high price volatility at 24.877%, it indicates that the rate of increase or decrease in price of oil is high and sporadic. The price volatility was calculated using the annual standard deviation of oil. Since the price of Brent oil was classified annually, there was not need of multiplying it with the square root of number of days to get the annual price volatility. The standard deviation was actually the price volatility (See excel file).
This test was conducted to test if there was any cointegration in the equation. In this test, the null hypothesis is rejected at the level where p-value is less than 5%, otherwise, it is accepted. In the trace statistic, the model had at most two cointegrations that had a p-value greater than 5%. This showed that the model had at least two cointegrations. In the Max_Eigen statistics, the model had at most two cointegrations that had a p-value that was greater than 5%. Therefore, the model had at least two cointegrations. This model indicated that the variable had a long run association. Therefore, all the four variables are cointegrated (Appendix 1 and 2).
This model was used to analyze the variables in the model since they were cointegrated. From the system equation, which developed at this stage, we were able to identify the target model. C(1) ,which was in the target model, shows the speed of adjustment towards long run equilibrium. It must be significant and negative. Since it was not negative, it showed that there was no long run causality from the independent variables, Brent oil price, revenue from oil, and government spending, on UAE’s GDP. Therefore, the independent variables did not have any influence on the dependent variable (UAE’s GDP) in the long run. That is, there was no long run causality from Brent oil price, revenue of oil, and the government spending to the GDP. Specifically, C(1) must be significant and negative for the independent variable to affect the dependent variable (Appendix 3, 4 and 5).
We performed a Wald test to identify if the independent variables affect the GDP in the short run. In the Wald test for crude oil, the Chi Square and the corresponding p-value are selected to determine the null hypothesis. As a standard rule, if the p-value is less than 5%, the hypothesis is rejected, otherwise it is accepted. In this case, the p-value was 16.6%, hence it was accepted. Accordingly, this revealed that the crude oil revenue did not affect the country’s GDP in the short run. In the Wald test of Brent price of crude oil, the p-value that corresponded to the Chi-Square was 20.96%. As a result, we accepted this hypothesis that the price of Brent oil does not affect UAE’s GDP in the short run. The Wald test for government spending had a p-value of 2.7% that corresponded to the Chi-Square. As a result, we rejected the null hypothesis, which stated that government spending does not affect UAE’s GDP in the short run. The model showed that in the short run, government-spending affects the country’s GDP (Appendix 6,7, and 8).
In summary, the research found that:
- There is no long run causality between government spending, price of Brent oil and revenue from crude oil on UAE’s GDP.
- In the short run, however, government spending has causality in the country’s GDP.
- Price of Brent oil and revenue from crude oil do not have any effect in the short run.
Accuracy of the model was examined by checking the R-Squared to find if it had any statistical error. The R-Squared was found to be high at 0.7395, which showed that the model was accurate (Appendix 9). The Breusch-Pagan-Godfrey model was used to check heteroscedasticity. Since the p-value for the Chi Square was 0.1768, at the Obs*R-Squared level, the model did not have heteroscedasticity (Appendix 10). The test of normality was done using the Jarque-Bera model, which showed a probability of 0.817 (Appendix 11). These results indicated that the residuals of the model are normally distributed.
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Appendix 1: Johansen Cointegration
Appendix 2: Johansen Cointegration
Appendix 3: Entire System Equation
Appendix 4: Target Model
Appendix 5: VECM
Appendix 6: Crude Oil Wald Test
Appendix 7: Brent Oil Wald Test
Appendix 8: Governments Spending Wald Test
Appendix 9: Accuracy of the Model
Appendix 10: Breusch-Pagan-Godfrey
Appendix 11: Jarque-Bera
Appendix 12: Regression Equation