Malaysia’s Trade Balance and Its Determinants: an Empirical Study from 1983 to 2023

Tan, Si Yin (2025) Malaysia’s Trade Balance and Its Determinants: an Empirical Study from 1983 to 2023. Final Year Project (Bachelor), Tunku Abdul Rahman University of Management and Technology.

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Abstract

This paper empirically examines the factors that influence the balance of trade in Malaysia during the period 1983 and 2023 with particular interest on the effect of exchange rates, inflation and foreign direct investment (FDI) and GDP growth. Based on the Autoregressive Distributed Lag (ARDL) bounds testing methodology and an Error Correction Model (ECM), the study determines long-run equilibrium relations as well as short-run dynamics. The results confirm that there is a long run cointegration of the variables. One main outcome is that depreciation of the exchange rate enhances trade balance considerably in the long run just in line with the Marshall-Lerner condition. On the other hand, both the GDP growth and inflows of FDIs show a very negative long-run correlation with the trade balance implying that growth in the economy and some FDI may raise the dependency in imports. It also displays a positive long-run effect of inflation, which is probably through the suppression of domestic demand and imports. In the short-run analysis, the adjustment rate of 41.3 percent per year towards the long-run equilibrium and the indicators of J-curve effect of exchange rates are observed. Diagnostic tests also established that the model was stable, but a structural break was observed between the 2012-2016 period, which was explained by global commodity price falls and changes in domestic policies. The research concludes that exchange rate policy is an effective instrument, but the growth and FDI are not automatic advantages. To achieve sustainable trade outcomes, policymakers are thus advised to use a strategic, managed exchange rate regime and direct FDI on export-oriented industries carefully