Analysis if the factors affecting exchange rate variability in Pakistan

Abstract

Most of the analyst, economist and policymakers have favoredfloating exchange rate system over fixed exchange rates because floating exchange rate absorbs the variations in foreign markets in a better way in the existence of an efficient market of foreign exchange.There are certain variables that have an effect on the exchange rate such factors are inflation, interest rate, growth, imports, exports and oil prices.Central Bank needs to assure that such factors are controlled and it has a strict control over the foreign exchange market and Banks.Pakistan is a small economy involved in foreign trade. The currency of Pakistan is Rupee, which has depreciated a great deal since the independence of Pakistan in August 1947, as a result of which Pakistani exports become expensive in the international market and lost the competitiveness and imports became inexpensive due to which the balance of trade got affected. As a result State Bank of Pakistan delinked the rupee from dollar and adopted a manage float system in 1982.From 2000 onwards SBP has used different mechanisms and tried to stabilize the exchange rate. These efforts have helped in stabilizing the exchange rate in from 2000 to 2008 but still fluctuations were also there and in the recent years the exchange rate has become volatile(Mahmood et al, 2011). The volatility of the exchange rates can have an adverse effect on the economy.To understand the exchange rate behavior the variable affecting the exchange rate needs to be studied