EuroEconomica, Vol 36, No 2 (2017)

Abstract

The study re-investigates the validity of the purchasing power parity (PPP) for Brazil, Russia, India, China (PR) and South Africa. These countries trade amongst themselves and are known as BRICS. We test if nominal exchange rates and relative prices are cointegrated for these countries and also find out if the cointegration is of linear or nonlinear form. A rank test for cointegration and a score test for nonlinearity are employed in our analysis.

Our results fail to reject the null of no cointegration between nominal exchange rates and relative prices for all the five countries. However, there is cointegration between nominal exchange rate, CPI for China (PR) and CPI for the US. Further analysis shows that the long-run relationship between nominal exchange rate, CPI for China and CPI for the US is nonlinear. The results imply that we cannot use the PPP as a basis for determining the equilibrium exchange rates for Brazil, Russia, India and South Africa because of the existence of arbitrage opportunities which traders are likely to exploit. However, it is difficult to make unbounded gains from arbitrage in traded goods in China (PR). The study provided new evidence on the validity of PPP in the BRICS by the use of nonlinear cointegration rank and score test.