Basket peg or flex: A template for assessing the competitiveness of Pakistan’s trade sector

This paper has been divided into two parts. The first part explores the appropriate exchange rate system for improved competitiveness of Pakistan’s trade sector. The second part finds out the solution of question that how to determine the optimal baskets and how heavily the euro and US$ ought to be weighed in any such currency baskets. It has been argued that at least two important targets, viz. Appropriate exchange rate regime and trade competitiveness need to be taken into account when determining an optimal basket. Drawing on a simple game, regression models are developed based on empirical evidences provided by Abed, Erbas and Guerami (2003). This paper has developed a simple framework within which the optimal exchange rate response to a change in weights of two currencies in the dollar-euro basket pegs. The results propose that Pakistan’s external sector competitiveness ought to be insensitive to euro & dollar exchange rate changes. In other words, Pakistan should continue its prevailing floating exchange rate regime. Using the consumer pricebased indices, the appreciation, or depreciation of Real Effective Exchange Rates (REER) applies to euro and dollar has been analyzed for Pakistan from 1982 to 2005.