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Equilibrium Real Effective Exchange Rate and Exchange Rate Misalignment in Pakistan

Author

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  • Zulfiqar Hyder

    (State Bank of Pakistan)

  • Adil Mahboob

    (State Bank of Pakistan)

Abstract

This paper estimates equilibrium real effective exchange rate (EREER) and exchange rate misalignment for Pakistan. Using the annual data from FY78 to FY05, Engle Granger co-integration technique is used to estimate the EREER based on various macroeconomic fundamentals suggested in economic literature by Edwards (1988, 1989, 1994), Elbadawi (1994), and Montiel (1997). The results indicate that EREER is determined by terms of trade, trade openness, net capital inflows, relative productivity differential, government consumption, and workers’ remittances. Trade openness, the increase in government consumption and capital inflows depreciate the REER, while, the increase in workers’ remittances and the improvement in terms of trade and total factor productivity relative to trading partners appreciate REER. The coefficients of the error correction term indicate the gradual convergence of the exchange rate toward long-run equilibrium. The estimated long run EREER and degree of exchange rate misalignment reveal that exchange rate misalignment ranged between -11.1 percent to 20.1 percent with zero reversion mean from FY78 to FY05 reflecting the long-term convergence tendency of actual REER toward EREER in Pakistan. Furthermore, the actual REER of FY05 is slightly depreciated in the range of 1.8-2.4 percent on the basis of two estimated regressions while one equation reflects an appreciation of 2.0 percent relative to EREER. This suggests that the current exchange rate is not too far away from the EREER and more or less reflects the underlying macroeconomic fundamentals. The result also reflects that the exchange rate misalignment and its volatility in REER measured by standard deviation tend to be smaller in the flexible exchange rate regime as compared to others

Suggested Citation

  • Zulfiqar Hyder & Adil Mahboob, 2006. "Equilibrium Real Effective Exchange Rate and Exchange Rate Misalignment in Pakistan," SBP Research Bulletin, State Bank of Pakistan, Research Department, vol. 2, pages 237-263..
    • Handle: RePEc:sbp:journl:13
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    References listed on IDEAS

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    Cited by:

    1. Adolfo Barajas & Ralph Chami & Dalia Hakura & Peter Montiel, 2011. "Workers’ Remittances and the Equilibrium Real Exchange Rate: Theory and Evidence," Economía Journal, The Latin American and Caribbean Economic Association - LACEA, vol. 0(Spring 20), pages 45-99, January.
    2. Farid Makhlouf & Mazhar Mughal, 2013. "Remittances, Dutch Disease, And Competitiveness: A Bayesian Analysis," Journal of Economic Development, Chung-Ang Unviersity, Department of Economics, vol. 38(2), pages 67-97, June.
    3. Nadia Tahir, 2013. "Forward-Looking and Backward-Looking Taylor Rules: Evidence from Pakistan," Lahore Journal of Economics, Department of Economics, The Lahore School of Economics, vol. 18(2), pages 121-145, July-Dec.
    4. Naved Hamid & Azka Sarosh Mir, 2017. "Exchange Rate Management and Economic Growth: A Brewing Crisis in Pakistan," Lahore Journal of Economics, Department of Economics, The Lahore School of Economics, vol. 22(Special E), pages 73-110, September.
    5. Muhammad Omer & Omar Farooq Saqib, 2009. "Monetary Targeting in Pakistan: A Skeptical Note," SBP Research Bulletin, State Bank of Pakistan, Research Department, vol. 5, pages 53-81.
    6. Farid Makhlouf & Mazhar Mughal, 2013. "Remittances, Dutch Disease, And Competitiveness: A Bayesian Analysis," Journal of Economic Development, Chung-Ang Unviersity, Department of Economics, vol. 38(2), pages 67-97, June.
    7. Fizza Malik, 2016. "Modeling Dynamics of Exchange Rates Volatility: A Case of Pakistan from 1980-2010," Bulletin of Business and Economics (BBE), Research Foundation for Humanity (RFH), vol. 5(3), pages 144-161, September.
    8. Ujjal Protim Dutta & Partha Pratim Sengupta, 2018. "Remittances and Real Effective Exchange Rate," South Asia Economic Journal, Institute of Policy Studies of Sri Lanka, vol. 19(1), pages 124-136, March.
    9. Amar Iqbal Anwar & Colin F. Mang, 2022. "Do remittances cause Dutch Disease? A meta-analytic review," Applied Economics, Taylor & Francis Journals, vol. 54(36), pages 4131-4153, August.
    10. Jesus Felipe, 2009. "Does Pakistan Need To Adopt Inflation Targeting? Some Questions," SBP Research Bulletin, State Bank of Pakistan, Research Department, vol. 5, pages 113-162.
    11. Dorsaf Sridi & Wafa Ghardallou, 2021. "Remittances and disaggregated country risk ratings in Tunisia: an ARDL approach," Middle East Development Journal, Taylor & Francis Journals, vol. 13(1), pages 191-211, January.
    12. Muhammad ASIF & Kashif RASHID, 2011. "Impact of Devaluation on Trade Balance in Pakistan," Oeconomics of Knowledge, Saphira Publishing House, vol. 3(3), pages 16-25, July.
    13. Matthew McCartney, 2015. "The Missing Economic Magic: The Failure of Trade Liberalization and Exchange Rate Devaluation in Pakistan, 1980–2012," Lahore Journal of Economics, Department of Economics, The Lahore School of Economics, vol. 20(Special E), pages 59-86, September.
    14. Mariem Brahim & Nader Nefzi & Hamed Sambo, 2017. "Remittances and the real effective exchange rates in MENA countries: What is the long run impact?," Working Papers hal-01583564, HAL.
    15. M. Lopreite, 2012. "The endogenous money hypothesis and securitization: the Euro area case (1999-2010)," Economics Department Working Papers 2012-EP02, Department of Economics, Parma University (Italy).
    16. Montiel, Peter J & Spilimbergo, Antonio & Mishra, Prachi, 2010. "Monetary transmission in low income countries," CEPR Discussion Papers 7951, C.E.P.R. Discussion Papers.
    17. Zeyneb GUELLIL & Fatima Zohra MAROUF & Mohammed Benbouziane, 2017. "Exchange Rate Regimes and Economic Growth in Developing Countries: An Empirical Study Using Panel Data from 1980 to 2013," MIC 2017: Managing the Global Economy; Proceedings of the Joint International Conference, Monastier di Treviso, Italy, 24–27 May 2017,, University of Primorska Press.
    18. Zainab Jehan & Iffat Irshad, 2020. "Exchange Rate Misalignment and Economic Growth inPakistan: The Role of Financial Development," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 59(1), pages 81-99.
    19. Mariem Brahim & Nader Nefzi & Hamed Sambo, 2017. "Remittances and the real effective exchange rates in MENA countries: What is the long run impact?," CEPN Working Papers hal-01583564, HAL.
    20. Adnan KHURSHID & Yin KEDONG & Adrian Cantemir CĂLIN & Zhaosu MENG & Naila NAZIR, 2018. "Remittances Inflows, Gain of Foreign Exchange or Trade Loss? New Evidence from Low, Lower-Middle and Middle-Income Groups," Journal for Economic Forecasting, Institute for Economic Forecasting, vol. 0(1), pages 20-41, December.
    21. Burhan Ahmad & Ole Gjølberg, 2015. "Are Pakistan’s Rice Markets Integrated Domestically and With the International Markets?," SAGE Open, , vol. 5(3), pages 21582440155, July.
    22. Farid Makhlouf & Mazhar Yasin Mughal, 2013. "Remittances, Dutch Disease, and Competitiveness: a Bayesian Analysis," Post-Print hal-01884858, HAL.
    23. Sarah Lynne Salvador Daway-Ducanes & Maria Socorro Gochoco-Bautista, 2019. "Manufacturing and Services Growth in Developing Economies: ‘Too Little’ Finance?," Progress in Development Studies, , vol. 19(1), pages 55-82, January.
    24. Hassan, Rubina & Shahzad, Mirza Muhammad, 2011. "A macroeconometric framework for monetary policy evaluation: A case study of Pakistan," Economic Modelling, Elsevier, vol. 28(1-2), pages 118-137, January.

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