1. On the impact of kuna exchange rate on Croatian foreign trade results: Elasticity approach Petar Sorić

2. Presentation structure Motivation and subject of research Data & econometric methods Theoretical background Related literature review Empirical models Econometric results and their implications Concluding remarks

3. Motivation and subject of research Permanently unfavourable Croatian foreign trade results The myth of overvaluated kuna exchange rate Need of more detailed foreign trade exploring

4. Motivation and subject of research TB reaches it’s low point in 1997, Q4; stagnation from 2002 rer’s follow the tb trend line until 2003, when they diverge Series means are adjusted in order to fit on the graph

5. Data & econometric methods Quarterly data, 1996Q1 to 2007Q4, seasonally adjusted and in logarithms otb=ln(X)-ln(IM) orer data obtained by correcting nominal exchange rate for the ratio of foreign and domestic price level (CPI) orer increase=appreciation Johansen’s approach used in order to obtain both the short run (VECM) and the long run elasticity coefficients (cointegration vector) J-curve analysis

6. Theoretical background Marshall-Lerner condition J-curve

7. Related literature review Turkalj (2005): small (but expected) estimated imports and exports exchange rate elasticities (OLS) Mervar (2003): income effect dominates over the exchange rate impact (PSS) Stu č ka (2003): Existence of the J-curve, estimated long-run rer coefficient of 0.9-1.3% (ARDL, PSS, Bewley ARDL)  Analysis results differ with respect to the used method

8. Empirical models “Catch all” model tb = f(gdp_cro, gdp_de, gdp_aut, gdp_ita, rer_de, rer_aut, rer_ita) Three disaggregated models (CRO vs.DE, CRO vs. ITA and CRO vs. AUT) tb = f(gdp_cro, gdp_de, rer_de) tb = f(gdp_cro, gdp_ita, rer_ita) tb = f(gdp_cro, gdp_aut, rer_aut)

9. rankeigenvalue tracep-value 00.86921274.180.000* 10.75404184.670.000* 20.65149122.960.001* 30.4956376.5770.052*** 40.3484846.4610.202 50.2723427.6100.263 60.1711813.6210.324 70.114695.36010.255 Source: Author's calculation Note: *denotes rejection of the null hypothesis of no cointegration at 1% significance level, ***denotes rejection at 10% significance level Results of Johansen's cointegration test “Catch all” model

10. The following restrictions were imposed: β tb =1 α rer_aut = α gdp_ita = α gdp_aut = α gdp_cro =0 β gdp_cro = -1; α rer_aut = α rer_de β gdp_aut =- β gdp_de Above mentioned restrictions were jointly accepted by a LR test (, p-value of 0.2670)

11. Econometric results and their implications tb t = -153.60 + gdp_cro t -2.88gdp_de t + 2.88gdp_aut t + 5.03 gdp_ita t + 6.63rer_de t + 8.399 rer_aut t -11.88 rer_ita t Unexpected gdp_de and gdp_cro sign: Croatian exports structure uncorrespondance to German imports demand rer_de and rer_aut coefficients: tb worsening as a long-run result of kuna depreciation (exports is often generated by imports in Croatia, e.g. shipbuilding)

12. VEC model variablecoefficientt-valuevariablecoefficientt-value Δtb t-1 0.4607900.898Δgdp_aut t-2 5.411581.89 Δtb t-2 -0.230929-0.468Δgdp_aut t-3 1.178470.409 Δtb t-3 0.1500000.346Δgdp_aut t-4 5.407801.83 Δtb t-4 -0.684785-1.62Δrer_de t-1 -12.9903-0.976 Δgdp_cro t-1 4.114792.35Δrer_de t-2 5.783250.452 Δgdp_cro t-2 -3.56807-1.51Δrer_de t-3 4.885990.411 Δgdp_cro t-3 -1.56398-1.03Δrer_de t-4 3.041970.204 Δgdp_cro t-4 -2.80733-2.22Δrer_ita t-1 10.42751.84 Δgdp_de t-1 -7.13117-1.18Δrer_ita t-2 0.4610340.121 Δgdp_de t-2 -1.15130-0.189Δrer_ita t-3 -2.634890.891 Δgdp_de t-3 5.857030.918Δrer_ita t-4 -4.88785-1.75 Δgdp_de t-4 0.06648820.0113Δrer_aut t-1 0.3975080.0324 Δgdp_ita t-1 -3.30309-0.659Δrer_aut t-2 -7.80636-0.666 Δgdp_ita t-2 9.454951.80Δrer_aut t-3 -0.628294-0.0569 Δgdp_ita t-3 -8.92433-1.33Δrer_aut t-4 0.6231530.0468 Δgdp_ita t-4 1.723590.413constant106.5681.78 Δgdp_aut t-1 -2.99187-1.22ECT t-1 -0.347350-1.78

13. test test statisticsp-value AR 1-1 test F(1,5) = 2.7624 0.1574 ARCH 1-1 test F(1,4) =0.0036441 0.9548 Normality test χ 2 (2) = 5.3125 0.0702 RESET test F(1,5) = 0.54866 0.4922 Properties of VECM residuals

14. Croatia vs. Germany rankeigenvalu e tracep-value 00.4806154.2340.010* 10.4002025.4100.152 20.0485632.91850.963 30.72814 0.393 Results of Johansen's cointegration test for CRO vs. DE model Source: Author's calculation Note: *denotes rejection of the null hypothesis of no cointegration at 1% significance level

15. tb t = -0.39gdp_cro t + 2.27 gdp_de t + 1.43rer_de t GDP coefficients confirm economic theory rer_de elasticity coefficient suggests tb deterioration in case of a devaluation  Uncompetitive economic structure  Import dependency of the Croatian economy

16. Croatia vs. Italy rankeigenvalue tracep-value 00.4591139.3420.250 10.1946212.3020.917 20.0611252.77840.969 37.099E-0050.003120.955 Source: Author's calculation Results of Johansen's cointegration test

17. Direction of causalityF-statisticProbability dgdp_cro → dtb0.317610.72985 dtb → dgdp_cro0.208640.81263 dgdp_ita → dtb0.005350.99467 dtb → dgdp_ita0.511840.60357 drer_ita → dtb1.730820.19117 dtb → drer_ita0.934910.40170 dgdp_ita → dgdp_cro0.170430.84396 dgdp_cro → dgdp_ita2.576280.08964 drer_ita → dgdp_cro0.429350.65413 dgdp_cro → drer_ita3.630600.03633 drer_ita → dgdp_ita0.434030.65115 dgdp_ita → drer_ita2.044700.14379 Granger causality test results  Relationship direction opposed to the expected?

18. Croatia vs. Austria rankeigenvaluetracep-value 00.4712348.1810.045* 10.3110920.1430.424 20.0738823.74730.916 30.00837670.370130.543 Results of Johansen's cointegration test for CRO vs. AUT model Source: Author's calculation Note: *denotes rejection of the null hypothesis of no cointegration at 1% significance level,

19. Confirmation of the CRO vs. DE model conclusions rer_aut coefficient opposed to economic theory tb t = -0.82gdp_cro t + 1.91gdp_aut t + 0.71 rer_aut t

20. Concluding remarks Marshall-Lerner condition & J-curve nonvalidity in Croatia? Real economic problems should primarily be solved by real variables and measures? Possible shortcomings: o short time span o the need of including other trade partners in the analysis Kuna devaluation effects should be observed much wider