## 1. INTRODUCTION

International trade plays an essential role in the economy of a nation, including Indonesia. It stimulates changes in the economic factors that lead to higher eco-nomic growth. Hasoloan (2013) stated that international trade encourages a country to provide specialization in producing their goods and services. The history of international trade can be seen from the balance of payments. The development of Indonesia’s foreign sector and its international balance of payments are influenced by many economic factors including inflation, interest rates, exchange rates, and global economy (Astuti *et al*., 2015;Falianty, 2018;Purwono *et al*., 2018).

The balance of payments of a country strongly determines the economic condition of a country (Masdjojo, 2005). The deficit international balance of payment is an external problem experienced by many developing countries (Sujianto and Suryanto, 2018;Wulandari *et al*., 2019). In developing countries, the balance of payments deficit caused by trade balance deficit often raises many concerns. Policies to stabilize the balance of payments by promoting trade and maintaining economic growth are needed (Boateng and Ayentimi, 2013). Meanwhile, there are internal factors that affect the balance of payments performance such as the conditions of a country’s macroeconomic fundamentals and domestic economic shocks (Fitri, 2014). Indonesia’s economic growth in 2016 was sustained by a well-maintained domestic economic stability. It indicated by low inflationary pressures, a decline in the current account deficit, continued control of the rupiah exchange rates, and well-maintained financial system stability (Sujianto and Effendi, 2016).

Indonesia’s balance of payments experienced the highest surplus in 2010 and experienced the highest deficit in 2013. In 2010, Indonesia’s balance of payments recorded a surplus of 30.28 billion USD because during the fourth quarter of 2010 the capital and financial transactions increased a surplus of up to 9.9 billion USD. In 2013, Indonesia’s balance of payments recorded a deficit of 7.3 billion IDR (Bank Indonesia, 2017). This condition is affected by the global economy, declining commodity prices, and shrinking capital flows to the developing countries. In the midst domestic economy structure that does not support external resilience (Muchdie and Narmaditya, 2019). Foreign exchange reserve is significant for a country. Countries with strong foreign exchange reserves can maintain the continuity of their economic activities and can push the economic growth. For developing countries like Indonesia with adequate foreign exchange reserves, debt repayment and provision of foreign exchange can be realized to maintain the stability of rupiah to the USD exchange (Sujianto, 2018).

Many factors influence the changes in the bal-ance of payments. One of which is a monetary approach to the balance of payments developed by Johnson (2016) and Mundell (1960). The main feature of this approach is to understand the international balance of payments as a monetary phenomenon. Foreign exchange reserves are essential for a country. Countries with substantial foreign exchange reserves can maintain the continuity of their economic activities and can push the economic growth.

Numerous studies have been conducted on bal-ance of payments in various countries such as (Duasa, 2004;Eita and Gaomab, 2012;Imoughele and Ismaila, 2015;Osisanwo *et al*., 2015;Umoru and Odjegba, 2013). Osisanwo *et al*. (2015) remarked that the balance of payments enhanced economic growth in Nigeria. Indeed, Eita and Gaomab (2012) showed that an increase in gross domestic product and interest rates lead to a greater balance of payment in Namibia. Umoru and Odjegba (2013) revealed that the exchange rate has affected the balance of payments in Nigeria. In addition, Imoughele and Ismaila (2015) stated that inflation has a negative effect on the balance of payments stability in Nigeria. Furthermore, Duasa (2004) provided an evidence on the long-term relationship between trade balance and income and money supply in the Malaysian economy. Eita and Gaomab (2012) stated that an increase in the interest rates has a positive impact on Namibia’s current account.

However, limited number of researchers are fo-cused on the balance of payment in Indonesia. Falianty (2018), for instance, focused on the current price of exported and imported commodities in Indonesia. Unfortunately, the previous studies do not include macroeconomic variables and its impact on the Indonesia’s balance of payment. Therefore, the main purpose of this study is to examine the relationship between macroeconomic factors and the balance of payments in Indonesia.

## 2. METHODOLOGY

This study applied quantitative research using Vector Error Correction Model (VECM) to determine the relationship between the variables in the short-term and the long-term. The data used in this study are secondary data from various sources, including data from Bank Indonesia and Statistics Indonesia from 2010 to 2017. The assumptions that must be fulfilled in VECM are stationary at the data speed of the first difference and the data has a cointegration relationship. VECM restricts the long-term relationship of endogenous variables to converge into their cointegration relationship but still allows the existence of short-term dynamics.

Notes:

## 3. RESULTS

### 3.1 Stationary Test Data

The first step taken for VECM estimation is testing data stationarity of each variable, both the dependent variable and the independent variables. In this study, to detect stationarity of each variable, the ADF test (Augmented test Dickey-Fuller) is applied by comparing ADF statistics with critical Mac Kinnon’s values at a significant level of 1 percent, 5 percent, and 10 percent, respectively.

Based on Table 1, it can be seen that the balance of payments, exchange rate, GDP, interest rates, and inflation are not stationary at the level indicated from p-value greater than alpha (α = 0.05). Therefore, data is formed at the level of first difference. Stationarity test results for the first difference in the balance of payments, exchange rates, GDP, interest rates, and inflation have a p-value smaller than alpha (α = 0.05). Hence, all variables are stationary at the level of first difference.

### 3.2 Lag Length Test

Testing of lag length shows how long the impact has occurred from the independent variable to the dependent variable.

Table 2 provides an information about the result of lag length test. From the table, it is known that the optimal lag length is in lag 2, yet, there are more indications of lag orders selected by the carrier (‘). Therefore, the optimal lag length used in the study this is lag 2.

### 3.3 Cointegration Test

Cointegration test is carried out to determine the existence of relationships between variables, especially in the long run. The cointegration relationship has a role which is very important in the VECM model. If cointegration relationship do not present between the variables, VECM estimation can be cancelled and be replaced with VAR method. The cointegration test is performed using Johansen method with a critical value of 5 percent or 0.05.

Table 3 presents the cointegration test result of the study. The result showed that in the 5 percent (0.05) level there are two cointegration related variables. It indicated that by trace values, the statistics 137.5400, 61.90855, and 29.87673 are greater than the critical value of 0.05, namely 69.81889, 47.86613, and 29.79707, respectively. Thus, the variables in this study has a long-term relationship between one another. Therefore, the VECM estimation can be used in this study.

### 3.4 Granger Causality Test

The Granger causality test is applied to under-stand whether two variables have reciprocal relationship. Variables are said to have relationships feedback if the probability value is less than 0.05. It means that one variable has a significant reciprocal relationship with other variables.

Table 4 provides information on the result of Granger causality test between the variables. From the table, the variables which have a causal relationship are shown by the probability level of not more than 0.05 and vice versa. From this calculation, it can be concluded that there is no reciprocal relationship between the variables including exchange rate, BI rate, GDP, inflation, and balance of payments. The absence of a reciprocal relationship between the variables means that the calculation can be continued to the VECM test.

### 3.5 The VECM Estimation

The use of VECM estimation is aimed to identify the short-term and long-term relationships and the influence of independent variables on the dependent variable. In the VECM estimation, if the value of t-statistic is higher than t-table, then it can be stated that there are long-term or short-term relationship between the variables. Long- or short-term relationships can be interpreted as the existence of effects that arise between the variables, both positive or negative influences.

The study has 32 and 5 variables data observation. With the use of α = 5% (0.05), the t-table used is 1.70329. In the optimal lag test, the data used in this study shows the optimal level in the second lag, hence, from the VECM estimation used in this study, we can see a statistical comparison between t-statistic and t-table. If t-statistics > t-table variables have either long-term or short-term relationship.

## 4. DISCUSSION

Based on the results of the analysis, it is known that in the long-run the exchange rate has a negative and significant influence on the balance of payments, but within short-term period, exchange rates have no significant positive effect. Based on monetarist approach theory, when a domestic currency price experiences depreciation, or foreign currency experiences appreciation, it can increase the balance of payments. Domestic prices will increase. This depreciation can improve the balance of payments through increasing capital inflows from investors as a result of rising interest rates in response to the increases domestic prices and the increased demand for domestic money.

Long-term results are not in line with the theory of monetary approaches. The results of this are in line with Umoru and Odjegba (2013) research, which stated that the appreciation of exchange rate affects the balance of payments in Nigeria. This is because be better developed in Africa, Nigeria imports machinery and technology that is very needed for its industrialization from outside. Furthermore, Mushendami *et al*. (2017) revealed that the appreciation of the Namibian Dollar would improve the balance sheet payment, and vice versa. This implies that the depreciation of exchange rate cannot be used to support the current transaction. This phenomenon can be ascribed to the nature of Namibia’s exports which are less sensitive to exchange rate changes.

The results of the calculation showed that in the short term exchange rate have a positive value but no significant effect. Odili (2014) stated that the exchange rates have no significant positive effect on the balance of payments in Nigeria. It implies that the changes in exchange rates do not affect Nigeria’s balance of payments in the short term.

### 4.1 The Relationship between National In-come and the Balance of Payments

Based on the results of the analysis, it is known that in the long term, GDP positively affects the balance of payment. Meanwhile in the short term, GDP has posi-tive but non-significant influence on the balance of pay-ment. According to the monetarist approach, a rise in GDP will stimulate money demand. The short-term money demand that can be fulfilled by the domestic amount of money will not affect the balance of payments. However, money demand that occurs in the long run will make a lack of money supply of money that encourage capital imports to Indonesia. The import of capital will increase the amount of foreign exchange reserve balance which means it can improve the balance of payments.

The results of calculation show that GDP, in the long run, has a positive and significant effect on the balance of payments. This result is in accordance with the monetarist approach theory on the balance of payments. The finding of the current study is in line with the research conducted by Boateng and Ayentimi (2013), which stated that GDP has a significant effect on Ghana’s balance of payments. The results of the research showed that the increase in GDP will also lead to the increase in foreign assets, GDP is an important factor in determining domestic reserves. Indeed, Fasanya and Olayemi (2018) revealed that economic growth in Nigeria is constrained by the balance of payment. The results of calculations show that in the short-term GDP have a positive and non-significant effect. This finding supports the previous study conducted by Effendy (2014) which mentioned that GDP in the short-term has a positive and non-significant effect on Indonesia’s balance of payment. On the contrary, Batool *et al*. (2018) stated that in the short-term GDP correlates with the balance of payment. This is because in the short-term the increase in GDP can improve the demand for money, and this can be met by the amount money that is in the country. Hence, it does not affect the balance of payments.

A broader study revealed a relationship be-tween per capita income and the quality of education as measured by human capital (Jamison *et al*., 2007). A study on countries that are members of the South Asian Association for Regional Cooperation (SAARC) that investment in the education sector will promote the eco-nomic growth (Hanif and Arshed, 2016). Meanwhile, according to Hanushek and Kimko (2000), the quality of education can increase the productivity that makes the economy to grow.

Education also affect students’ empowerment, which is, in the long run leads to the improvement of both productivity and performance (Aliafari *et al*., 2019). Furthermore, the higher labor productivity will increase the economic growth as stated in the study of Ponkratov *et al*. (2019), that in 2000-2018, the economic growth of Indonesia, China, Poland, and India was supported by the productivity of its human resources.

### 4.2 The Effect of Interest Rates on the Balance of Payments

Based on the analysis results, it is known that interest rates positively affect the balance of payment in the long run. While in the short-term, interest rates have a negative but no significant effect. According to the monetarist approach, interest rates have a positive correlation with the balance sheet payment. An increase in the interest rates will cause capital to flow into the capital and financial balance. In the long-term, it will increase the balance of payments.

Eita and Gaomab (2012) stated that an increase in interest rates has a positive impact on Namibia’s current account. Namibia Central Bank indicates several times that an increase in interest rates is needed to reduce unproductive imports to improve the current account. Furthermore, Eita and Gaomab (2012) mentioned that the increase in interest rates has led to the increase in the balance of payments in Namibia. Similarly, this finding is in line with the theoretical expectations that positive interest rates will attract capital inflows and increase the balance of payments.

The results of calculations in the short-term show that interest rates have a negative and no significant influence. This finding agrees with the prior study conducted by Shafi *et al*. (2015) which find negative relationship between interest rates and balance of payment in India and Pakistan. Similarly, this result supports Effendy (2014) who stated that in the short-term interest rates have a negative and no significant influence on Indonesia’s balance of payments. This happened because the high- interest rate will attract hot money to enter Indonesia and will trigger an appreciation on the exchange rate. Further, it will make the exports to become more expensive than the imports which will worsen the balance of payments and vice versa. The reason for the non-significant effect of interest rate is because the entering and exiting hot money has little influence on the fluctuation of exchange rate as the result of an inflation in the balance of payments.

### 4.3 The Relationship between Inflation and Balance of Payments

Based on the results of the analysis, it is known that inflation has a negative and significant influence on the balance of payments in Indonesia. In the short-term, inflation has no significant positive effect on the balance of payments. According to the monetarist approach, inflation has a negative relationship with the balance of payment. When domestic prices rise, it will lead to a reduced demand for domestic goods and services. This will increase the request for imported goods; thus, it has a negative impact on the balance of payment. The results of long-term calculations show that inflation has a negative influence on the balance of payments. When inflation rises, it will lead to the deficit on the balance of payments. Furthermore, the level of inflation in Indonesia is relatively low and it can lead to the economic growth and increase the national income. When the increase in national income caused by inflation is huge, it does not significantly increase the balance of payments (Astuti *et al*., 2015).

The previous study conducted by Imoughele and Ismaila (2015) mentioned that inflation has a negative effect on the balance of payments stability in Nigeria. This shows that the stability of macroeconomic policies is adequate in Nigeria. One of the triggers of inflation is the number of moneys in the circulation, which is higher than what is needed. If the money supply increases, it will result in people spending this excess money, for example, by importing or buying valuable foreign documents so that there is an outgoing capital flow which causes deficit in the balance of payments.

Similarly, this finding also supports that there is a negative correlation between inflation and the balance of payments (Aidi *et al*., 2018;Mwai, 2015). Inflation has invited primary attention from each nation, including Indonesia because it has a great impact on the national economy. When the inflation rate is high, it causes the decline in people’s purchasing power and national production. The decrease in national production will, in turn, causes a decline in the exports and affect the balance of payments performance. Whereas Manual and San (2019) stated that an increase in the inflation rate increases trade deficit and reduces the trade surplus, especially in Malaysia in the span of 15 years (2000 to 2015).

This result is in line with Effendy (2014) who stated that inflation has a positive and non-significant effect on Indonesia’s balance of payments. Inflation can have a positive effect because the inflation in Indonesia is relatively low, which in turn will promote the economy and increase national income. If National income going up, the balance of payments will rise. However, when the increase in national income is not significant it will not increase the balance of payments significantly.

### 4.4 Contribution

This study is expected to provide insight for the government policy concerning the balance of payment which should consider several macroeconomic factors such as inflation, exchange rates, interest rates, and national income. The quality of education also has a contribution in creating national economic growth. Therefore, human capital needs to be enhanced. This research provides new evidence on the relationship between macroeconomic factors and balance of payment in Indonesia.

## 5. CONCLUSION

This study examines the relationship between macroeconomic variables and the balance of payments in Indonesia. The findings showed that all variables have correlation with the balance of payments. More precisely, interest rates and national income positively affect the balance of payments. It implies that interest rates and national income stimulate greater increase in the balance of payment. On the other hand, the exchange rate and inflation have a negative correlation with the balance of payments. It showed that when the exchange rate and inflation increase, the balance of payments will decline. In the short-term, macroeconomic factors including the exchange rate, national income, interest rates, and inflation do not have a significant effect on Indonesia’s balance of payments. It implies that in the short-term, mac-roeconomic variables have less influence on the balance of payments.