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UNIVERSITI PUTRA MALAYSIA

TERM STRUCTURE, INFLATION, AND ECONOMIC GROWTH IN SELECTED EAST ASIAN COUNTRIES

ELGILANI ELTAHIR ELSHAREIF.

FEP 2007 17

TERM STRUCTURE, INFLATION, AND ECONOMIC GROWTH IN SELECTED EAST ASIAN COUNTRIES

BY

ELGILANI ELTAHIR ELSHAREIF

Thesis Submitted to the School of Graduate Studies, Universiti Putra Malaysia, in Fulfilment of the Requirement for the Degree of Doctor of Philosophy

October 2007

SPECL4LL Y DEDZCA TED TO My beloved mother, Alshahida Fatima; my father, Eltahir; my lovely wife, Rufida; and my lovely daughter, Lina; and my beloved sons, Mohamed and Munzir; and my

supportive brothers and sisters

Abstract of thesis presented to the Senate of Universiti Putra Malaysia in fulfilment of the requirement for the degree of Doctor of Philosophy

TERM STRUCTURE, INFLATION, AND ECONOMIC GROWTH IN SELECTED EAST ASIAN COUNTRIES

BY

ELGILANI ELTAHIR ELSHARIEF

October 2007

Chair: Associate Professor Tan Hui Boon, PhD

Faculty: Economics and Management

The issue of term structure of interest rates has been a much-researched area in

economics and finance in several developed economies for over a century. It is

argued that the term spread between long and short rates contain useful

information about future interest rates, inflation, and real economic activity

which is of great importance to policy makers.

This study attempts, first, to determine whether there is a time-varying risk

premium in the short-term interest rate, and secondly, to provide an in-depth

study on the term structure of interest rates and its impacts on the movements

of short-term interest rates, inflation rates and real output in the five selected

East Asian countries via an extended model of Expectation Hypothesis Theory

of Term Structure. The five selected Asian countries are Japan, South Korea,

Malaysia, Thailand and the Philippines. These objectives are achieved through

the employment of the Generalized Method of Moment and Ordinary Least

Square with Newey-West standard errors and Heteroskedasticity and

autocorrelation consistent covariance correction.

One interesting finding of this analysis is that there is a small risk premium in

the short-term interest rates of Japan and Thailand, whereas there is none in

those of Korea, Malaysia and the Philippines. This implies the stability of the

short-term interest rates in the latter. In all the five cases, regardless of a time-

varying risk premium in the interest rate, the term spreads of all these countries

seem to contain useful information for predicting movements in the short-term

interest rates. On the other hand, for the case of predicting the path of inflation

rate, only three countries, namely, Japan, Korea and Malaysia, indicate a

possible increase in future inflationary pressure. The two other countries, the

Philippines and Thailand, did not benefit any useful information regarding the

future inflation rates from term spreads, Similarly, the term spread also does not

provide any relevant information on the real output of Malaysia, the Philippines

and Thailand. However, it does provide relevant information for the case of

Japan and Korea.

The estimated results and findings of this study provide some very useful

insight on the information contained in interest rate term spreads of the five

countries. This useful information on interest rate, inflation and economic

activity can benefit both the government and private sectors of the five countries

PEWUSTAKAAN SULTAN ABDUL SAMAD UNNERSlTI WTRA MALAYSIA

in developing macroeconomic policies and gaining competitiveness in the

global market.

Abstrak tesis yang dikemukakan kepada Senat Universiti Putra Malaysia sebagai memenuhi keperluan untuk Ijazah Doktor Falsafah

TERMA STRUKTUR, INFLASI, DAN PERTUMBUHAN EKONOMI DALAM NEGARA ASIA TIMUR TERPILIH

Oleh

ELGILANI ELTAHIR ELSHARIEF

Oktober 2007

Pengerusi: Profesor Madya Tan Hui Boon, PhD

Fakulti: Ekonomi dan Pengurusan

Isu berkenaan terma struktur kadar faedah merupakan isu yang sering dikaji di

dalam bidang ekonomi dan kewangan di kebanyakan negara maju sejak se abad

yang lalu. Banyak perdebatan telah berlaku dalam membincangkan samada

julat terrna antara kadar faedah jangka panjang dan pendek mengandungi

maklumat mengenai kadar faedah masa hadapan, inflasi dan aktiviti benar

ekonomi, yang merupakan maklumat penting kepada pembuat-pembuat polisi.

Kajian ini bertujuan, pertamanya untuk menentukan samada terdapat premium

risiko masa berubah dalam kadar faedah jangka pendek, dan keduanya, untuk

memberikan kajian mendalam ke atas terma struktur kadar faedah dan

kesannya ke atas pergerakan kadar faedah jangka pendek, kadar inflasi, dan

pengeluaran sebenar bagi lima (5) negara Asia Timur terpilih dengan

menggunakan model tambahan kepada Teori Hipotesis Jangkaan terma

struktur. Kelima-lima negara yang terpilih tersebut adalah Jepun, Korea Selatan,

Malaysia, Thailand, dan Filipina. Objektif-objektif ini dicapai dengan

menggunakan Kaedah Am Masa dan OLS dengan piawaian kesilapan Newey

dan pembetulan HAC.

Salah satu penemuan menarik dari analisis ini ialah terdapat premium risiko

yang kecil di dalarn kadar faedah jangka pendek untuk Jepun dan Thailand,

tetapi tiada premium risiko di dalam kadar faedah jangka pendek untuk Korea

Selatan, Malaysia dan Filipina. Ini menunjukkan bahawa kadar faedah jangka

pendek untuk Korea Selatan, Malaysia dan Filipina adalah stabil. Tanpa

mengira samada terdapat premium risiko masa berubah dalam kadar faedah

jangka pendek, julat tenna untuk kesemua negara tersebut seperti

mengandungi maklumat berguna untuk meramalkan pergerakan kadar faedah

jangka pendek. Di sebalik itu, bagi tujuan meramalkan kadar inflasi, hanya tiga

(3) negara, iaitu Jepun, Korea Selatan, dan Malaysia menunjukkan

kemungkinan peningkatan tekanan kadar inflasi di masa hadapan. Bagi Jepun

dan Filipina pula, kajian ini menunjukkan bahawa tidak terdapat maklumat

berguna untuk meramalkan pergerakan kadar faedah jangka pendek dari julat

tenna untuk kedua-dua negara ini. Julat terma juga tidak memberikan apa-apa

vii

maklumat berguna terhadap pengeluaran benar untuk Malaysia, Filipina dan

Thailand tetapi terdapat maklumat berguna untuk Jepun dan Korea Selatan.

Keputusan-keputusan empirikal dan penemuan-penemuan dari kajian ini telah

memberikan satu pengertian yang mendalam tentang maklumat-maklumat

yang terkandung di dalam julat terma kadar faedah bagi lima (5) negara yang

terpilih. Maklumat-maklumat berguna ke atas kadar faedah, inflasi dan aktiviti

ekonomi ini boleh memberikan manafaat kepada pihak kerajaan dan sektor

swasta di kelima-lima negara yang terpilih dalam membangunkan polisi-polisi

makroekonomi dan meningkatkan daya persaingan dalam pasaran global.

viii

ACKNOWLEDGEMENTS

First and foremost, I would like to express my heartfelt thanks to the Almighty

for giving me the will, strength and the perseverance to pursue and complete

my Ph.D.

Then, I would like to express my sincere gratitude and appreciation to the

chairman of my supervisory committee, Associate Professor Dr. Tan Hui Boon

for her invaluable guidance, dedicated efforts, supervision and continuous

support throughout the study.

My special thanks and appreciation goes to my two other supervisory

committee members, Associate professor Dr. Zulkornain Yusop and Professor

Dr. Ahrnad Zubaidi Baharumshah, for their advice and feedback. Their

consistent encouragements have kept me going without which this PhD would

probably be just a dream.

Also, heartfelt thanks to all the staff of the Faculty of Economics and

Management, UPM, who have contributed in one way or another, throughout

the course of the study.

I am also grateful to my friends Yousif, Gasim, Abdallah ,Zubir, Hamed, Kevin,

Naseem, Dr. Marial, Dr. Gazi and Monjurul. I shall cherish and treasure the

happy moments we shared together in the Ph.D. lab. Thank you all for making

my student life interesting and delightful.

Last but not least, I would like to express my sincere and immeasurable thanks

to the stakeholders of my study, my family members, for their endurance,

patience and encouragements. Among them, especially, I wish to thank my

parents, wife, daughter, sons, brothers and sisters, especially, Alshaid Osam Ali.

I certify that an Examination Committee has met on 25fi October 2007 to conduct the final examination of Elgilani Eltahir Elshareif on his Doctor of Philosophy thesis entitled "Term Structure, Inflation, and Economic Growth in Selected East Asian Countries" in accordance with Universiti Pertanian Malaysia (Higher Degree) Act 1980 and Universiti Pertanian Malaysia (Higher Degree) Regulations 1981. The Committee recommends t