EFFECTS OF CRUDE OIL PRICE ON CURRENCY STABILITY– THE CASE OF MALAYSIA RINGGIT PEG (SEPTEMBER 1998-JUNE 2005)

Abstract

This study is carried out to investigate the impact of crude oil price fluctuationson Malaysian exchange rate as proxied by RM per USD.Even though there is no specific theory that explains the interaction between commodity and foreign exchange markets, the study is still pursued on Malaysia because of its resilient oil and gas industry.  Using Engle-Granger Cointegration Test (1987) as an estimation tool over monthly secondary data from January 1988 through October 2018, the results from Error Correction Model uncoversthe existence of long-term equilibrium relationship between RM and crude oil prices.  Interestingly, there is also a presence of short-run relation between themat 10% significance level.  With respect to the short-run dynamics, there is a unidirectional causality running from crude oil prices to RM exchange rate.  It appears that RM is less prone to changes in crude oil price during the period before Asian Debt Crisis in 1997-1998.   After the removal of RM peg in June 2005, RM is found to be more sensitive towards changes in crude oil price in the short run.In summary, the equilibrium and dynamic relationships between RM exchange rate and crude oil price are thereforeconfirmed and perhaps the quotation of crude oil price in USD could be one of the reasons.