Movement of Exchange Rate on Balance-of-Payments Constrained Growth in South Asia: Panel ARDL

Movement of the exchange rate is highly influential for the balance of payments in South Asia. Underpinning literature reveled both positive and negative impacts of real effective exchange rate on current account deficit. The objective of the paper is to understand the exchange rate movement on current account balance and to estimate the misalignment of exchange rates in South Asia. The study use empirical methods including Pooled mean group (PMG) regression, Mean group (MG) estimation, and Dynamic fixed effects (DFE) regression for estimating the predicted values for the current account deficit. Further, the exchange rate misalignment is estimated on the basis of Behavioural Equilibrium Exchange Rate (BEER) theory. The empirical results also support the Thirlwall’s hypothesis which states that balance of payments position of the South Asian economies are the main constraint on its economic growth. Panel Dynamic Ordinary Least Square (DOLS) method is used to estimate the misalignment using net foreign assets and productivity differential. The results show that in the long run of PMG model, Real effective exchange rate is negatively significant while GDP growth, Productivity, Trade openness, and Broad money (M2) are positively significant, imply those variables have positive impacts on current account balance. Since Hausman test revealed PGM as the efficient model to predict the relationship, in short run, EC and Real Effective Exchange Rate are negatively and Productivity and Trade openness are positively significant. The results of DEF model suggest that Real effective exchange rate is also negative, meanwhile GDP growth, Productivity, Net foreign assets, Trade openness, Terms of trade are positively predict the impacts on current account balance. Panel estimation of BEER model shows that the productivity differential and net foreign assets are significant positive predictors of the real effective exchange rate. Total misalignment is the difference between the fitted and actual value of the real exchange rate. These determinants of current account balance imply the effectiveness of targeting one of the variables in influencing the long run behavior of other variables by policymakers.