Pakistan’s External Trade: Does Exchange Rate Misalignment Matter for Pakistan?

M. Ashraf Janjua ()
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M. Ashraf Janjua: Dean, College of Business Management, Karachi, and Former Deputy Governor, State Bank of Pakistan.

Lahore Journal of Economics, 2007, vol. 12, issue Special Edition, 126-152

Abstract: This paper is primarily aimed at assessing the significance of the exchange rate on Pakistan’s foreign trade. It estimates the Equilibrium Real Effective Exchange Rate (ERER) and exchange rate misalignment for Pakistan using annual data from FY78 to FY06. The Engle Granger co-integration technique is used for the estimation of ERER depending upon various macroeconomic fundamentals as recommended by Edwards (1994). The results of the study are also used for the forecasting of ERER and misalignment up to the year 2010. The results of the study reveal that ERER is determined by variables such as: a) terms of trade, b) trade openness, c) net capital inflows, d) relative productivity differential, e) government consumption, and f) workers’ remittances. The error correction term points to the gradual convergence of the real exchange rate towards the long-run equilibrium level which suggests that the prevailing Pak Rupee exchange rate has not deviated from the ERER and captures economic fundamental trends. Moreover, Pakistan’s foreign trade would depend significantly upon the state of economic fundamentals in the future. Improved economic fundamentals are likely to support trade besides paving the way for enhanced inflows of capital and financial receipts.

Date: 2007
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