Capital Flows and Real Exchange Rate Overvaluation - A Chronic Ailment: Evidence from Pakistan
AbstractThe objective of this study is twofold: (i) to estimate the equilibrium real exchange rate (RER) from a long-run perspective and calculate the degree of overvaluation for the period 1972–2007, and (ii) to test the Dutch Disease hypothesis concerning the effect of capital flows on the RER in Pakistan. Based on various macroeconomic fundamentals suggested in economic literature by Edwards (1988, 1989, 1994), Elbadawi (1994), and Montiel (1997), the equilibrium RER is estimated as a function of the terms of trade, government spending, degree of openness, workers’ remittances, foreign direct investment (FDI) flows,and foreign economic assistance. In view of this study’s long-term focus, all unsustainable and temporary flows are filtered out to obtain an accurate misalignment index. Estimation results are in line with theoretical postulations: an increase in capital flows, government spending on nontradable goods and terms of trade improvement are consistent with an appreciation of the RER, while an increase in the degree of openness is expected to depreciate the RER. Findings suggest that the RER suffers from chronic overvaluation in Pakistan. In spite of filtering out unsustainable and temporary flows, overvaluation increased from 0.75% in 2001 to 22.9% in 2007. A sharp rise in FDI flows (between 2005 and 2007)and an increase in remittances (between 2002 and 2007) are amongthe main factors that have contributed to this persistent overvaluation. Results also suggest that the Dutch Disease hypothesis holds in the case of Pakistan.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoArticle provided by Department of Economics, The Lahore School of Economics in its journal Lahore Journal of Economics.
Volume (Year): 14 (2009)
Issue (Month): Special Edition (September)
Contact details of provider:
Postal: Intersection Main Boulevard Phase VI DHA and Burki Road, Lahore
Phone: (92-42) 6560939
Web page: http://www.lahoreschoolofeconomics.edu.pk/EconomicsJournal/LJEIntro.aspx
More information through EDIRC
Real exchange rate; capitalinflow; overvaluation; Pakistan.;
Find related papers by JEL classification:
- F10 - International Economics - - Trade - - - General
- G00 - Financial Economics - - General - - - General
- E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Capital; Investment; Capacity
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Salim Chishti & M. Aynul Hasan, 1993. "What Determines the Behaviour of Real Exchange Rate in Pakistan?," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 32(4), pages 1015-1029.
- Simon Johnson & Jonathan D. Ostry & Arvind Subramanian, 2007.
"The Prospects for Sustained Growth in Africa: Benchmarking the Constraints,"
NBER Working Papers
13120, National Bureau of Economic Research, Inc.
- Arvind Subramanian & Jonathan David Ostry & Simon Johnson, 2007. "The Prospects for Sustained Growth in Africa: Benchmarking the Constraints," IMF Working Papers 07/52, International Monetary Fund.
- M. Ashraf Janjua, 2007. "Pakistan’s External Trade: Does Exchange Rate Misalignment Matter for Pakistan?," Lahore Journal of Economics, Department of Economics, The Lahore School of Economics, vol. 12(Special E), pages 126-152, September.
- Ofair Razin & Susan M. Collins, 1997. "Real Exchange Rate Misalignments and Growth," International Finance 9707001, EconWPA.
- Elbadawi, Ibrahim A. & Soto, Raimundo, 1994. "Capital flows and long-term equilibrium real exchange rates in Chile," Policy Research Working Paper Series 1306, The World Bank.
- Usman Afridi, 1995. "Determining Real Exchange Rates," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 34(3), pages 263-276.
- Ofair Razin & Susan M. Collins, 1997. "Real Exchange Rate Misalignments and Growth," NBER Working Papers 6174, National Bureau of Economic Research, Inc.
- Dani Rodrik, 2008. "The Real Exchange Rate and Economic Growth," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 39(2 (Fall)), pages 365-439.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Shahid Salahuddin).
If references are entirely missing, you can add them using this form.