Exchange Rate Dynamics and Trade Balance Adjustment: Empirical Evidence from Pakistan

Abstract

Given Pakistan’s ongoing twin deficit, policymakers must comprehend the effect of exchange rate variations on its trade balance. This is imperative for implementing effective policies and promoting sustained economic growth in Pakistan. Current study observed the nexus between exchange rate and trade balance of Pakistan from 1984–2023. Study used the absorption, elasticity and monetary approaches as a theoretical framework and Autoregressive Distributed lag model as for empirical analysis. The estimated results show that all the variables have significantly affect trade balance and an increase in the exchange rate depreciation, GDP growth and inflation are positively associated with trade balance both in short and long run period. Fiscal deficit and broad money are negatively associated with trade balance in the short and long run analysis. One important policy implication is that economies need to fix fundamental imbalances in order to improve trade through the exchange rate and trade policies. This paper will highlight some new understandings for policy formulation regarding trade balance, exchange rate, fiscal imbalances and economic growth.