Role of Global Value Chains and Exchange Rate: An Empirical Examination in case of Pakistan

Pakistan’s economy has a history of facing continuous external sector shocks that often resulted in large exchange rate depreciations. Whether these depreciations have supported growth in exports from Pakistan or do more harm than providing any benefit to the economy is always a matter of domestic debate with inconclusive results. One major apprehension sighted in this regard is the role of intermediate imported goods that become expensive after depreciations and thus offset any competitive gains expected to be achieved from the exchange rate adjustment. To empirically investigate this argument, we evaluate that whether and how the Global Value Chains (GVCs) participation, i.e. the export and import of intermediate goods, affects the REER elasticity for exports in Pakistan using input-output model techniques. We find that, like elsewhere, REER elasticity of exports has declined in Pakistan overtime. However, only around 16 percent of this decline in REER elasticity is explained by the role of GVCs participation. One major reason for this lower impact could be coming from the fact that, unlike other emerging economies and in contrast to general perception, role of backward participation (i.e. use of imported inputs to produce exports) is one of the lowest in Pakistan. While the results still signify the role of PKR exchange rate in external adjustment, the low backward participation is not helping the exports to become competitive overtime.