Linkage of Exchange Rate and Trade: Empirical Evidence from Pakistan

Abstract

This study examines the relationship between the Real Effective Exchange Rate and Pakistan's exports and imports. This paper examines the processes occurring in Pakistan, namely the devaluation process and its impact on trade balances and the balance of payments. A time series dataset up to 2021 was acquired for the research, and after the unit root test for integrated variables, the long-run coefficients were estimated using the ARDL method. To further substantiate the existence of a long-term relationship between the variables, the limits test for cointegration was utilized. Consequently, the empirical data indicates that all coefficients of the independent variables have negative consequences for Pakistan's balance of payments. The boundaries test for cointegration assesses the existence of a long-term relationship. The author contends that devaluation has a minimal impact on Pakistan's balance of payments, necessitating alternative strategies to rectify trade balances. Furthermore, to augment its part of needs, the government must focus its efforts on promoting a higher amount of foreign direct investment through improved policies.