Professional Documents
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in Pakistan
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AROOJ BAIG
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Abstract
The study explore the interrelation between the volatile exchange rate and the
exports in the presence of Inflation. It uses the secondary or annual time series data from 1981 to
2018 in Pakistan . This study used the volatile exchange rate formula to determine the volatility
because it is not observable directly. This paper applied the unit root test and then applied the
ARDL approach according to the study nature. The study found a significant and negative long-
run relation and also negative significant short-run relation between exports and exchange rate
volatility.
1. Introduction
Exports is the key determinant that boost the growth of any economy. It is one of the
major macroeconomic variable. It also plays a vital role in supporting the terms of trade, balance
of payment and improvement in exchange rate. Foreign exchange is generated by exports. The
country which has resources and special skills to produce the goods needed by other country,
produce that and export to the country and take advantage.
Increase in the exports results in increases the foreign reserves. This helps the country in
managing the value of its own currency. Increase in the foreign reserves reduces the exports
costs of the exporter country. The comparative advantage is higher if the country do more export.
The country is getting expert in making the goods and services and able to know, how to deal in
foreign markets. Government should encourage exports. It increase the living standard, creates
more job opportunities with the increase in the wages.
The current condition of Pakistan is very serious and balance of trade is one of the major
issue that is much effected due to decrease in the volume of exports. Pakistan is a developing
economy and facing a trade deficit, which is the major issue of the developing economy
Volatile exchange rate is one of the factor that effect the exports. It decreases the volume of
trade. The Bretton wood system was collapsed in 1973 and floating exchange rate was approved
by many nations . Pakistan is one of the country which approved this in 1982
The contribution of exports of Pakistan is more than 20% that contribute in the GDP of
Pakistan, because Pakistan exports raw materials and some are refined that include garments,
rice, wheat, leather, hosiery products and cotton. In 1970 Pakistan adopted promotion policy. In
1980 it has improved for better formation. The policies regarding exports create employment
opportunities, education and also heath opportunities.
In 1998 the exports of Pakistan was declined due to experiment of nuclear but by the time
it started increasing and in 2000 it started increasing , growth rate was increased from1.8% to
7% annually in 2000-1. In 2016-17 there was 3.06 % declined in the exports . According to the
world bank the exports performance of Pakistan still weak. Exports share of Pakistan in world
exports was declined from 0.18% to 0.13% in 2017. But at the same time other countries share
were increased. In Sep 2019 it was recorded 1.8 USD bn and imports were 3.8% that shows 0.8
% increase. (Economic survey of Pakistan)
Many countries began to follow the flexible exchange rate to make an idea about how
currencies and trade volume effects each other. There are various studies that undertake this
problem but find unclear results. Exports show negative association with exchange rate volatility
means, international trade is discourage from exchange rate volatility.
Exchange rate volatility is cause by flexible exchange rate. It increases more risks and
make investment decisions more difficult. This will lead towards uncertainty about profit which
will happen in future. The profits are usually low, that’s why risk aversers tend to avoid risks.
The exchange rate volatility shows positive as well as negative effects on exports. Positive
association of exports with exchange rate volatility means that exports are encouraged by
uncertainty in exchange rate (Hussain et al).
There are contradictions in the results several studies show positive, negative or many
draw no conclusion. Kohlhagen and Hooper, 1978, said that in international trade, volatile
exchange rate is the main factor that increases high cost for traders. Positive association will
occur if income effect is dominant over substitution effect (De Grauwe, 1988).Pakistan trade
balance is in deficit . To overcome this, the exports of Pakistan should increase and the volatile
exchange rate is the major hurdle for expanding exports.
The previous hypotheses regarding volatile exchange rate, real export, shows significant
results. According to Khalid Mustafa, 2017 there is negative link of volatile exchange rate with
export growth But some studies don’t support this argument. Because there is mixed up effects
has shown by researchers. According to Kamuganga, 2012 and Rose, 2000 there is relationship
between exports and uncertain exchange rate that is linear in nature. Cushman (1983, 1986,
1988), Hilton and Akhtar (1984) and many other studies didn’t findout the clear results regarding
the study.
Positive relation of inflation with exports means when there is increase in the price level
in a country the bank increases the interest rate and the currency starts to depreciate and the
prices of goods and services is relatively is cheaper to other countries and in result the exports of
the country will increase. When a country`s exchange rate increases its currency starts to
depreciate and its products are relatively cheaper to other countries and its exports will increase.
Because a weak domestic currency increases exports rather than a strong domestic currency and
is the factor that increases the economic growth.
Inflation and exchange rate have positive link, but it negatively affect the currency of a
country. Exchange rate remain unchanged when there is same inflation in two countries. High
inflation decreases the currency`s values means its currency depreciate and it appreciates in the
forex market when there is low inflation. In 1982-83 Pakistan`s rupees was devalued up to 38.5
% that is 237 PKR . Because at that time the flexible exchange rate was approved. Excessive
exchange rate was recorded in 1980-81. In 2001 it began to decline that is 97 PKR. It was 106
PKR in 2011.
. The study for Taiwan and US trade on the exports of agriculture sector shows
significant results, while other sectors shows insignificant results. There is a study in case of
Pakistan that shows significant results with UK and UAE but insignificant relationship when
trading partner is USA. According to world bank the Pakistan`s inflation in 2014 was 7.18 % that
is very high but in 2015 it was 2.52 that was low but in 2016 the inflation rate was 3.7% ,but by
the time the inflation rate goes up. In 2017 it became 4.08% greater than before. In 2018 it was
highest than the previous three years that is 5.08%.
This study examined the relationship between exchange rate volatility and exports in the
presence of inflation from 1981 to 2018 in Pakistan There is a gap in the literature review that is
inflation because it is an important variable to determine the exports. . Real exports use as a
regressand while inflation, real exchange rate and exchange rate volatility use as regressors
.Inflation has positive association with exports. Exports and exchange rate have negative
association. Volatile exchange rate has negative association with exports.
The study undertakes the interrelation of volatile exchange rate on exports in the presence
of inflation along with annual time series analysis form 1981 to 2018 in Pakistan. This study
uses the moving standard deviation of exchange rate that is measured as time varying exchange
rate to measure the exchange rate volatility.
Because other studies didn’t show the how exchange rate volatility effects exports
growth in the light of inflation. And didn’t use the formula of exchange rate volatility. This study
is advance from previous studies and shows more favorable methodology with more clarified
variables.
The aim of the paper is to undertake the empirical effect of volatile exchange rate on export
growth in the presence of Inflation
2. Literature Review
The following table shows the literature review of different 30 studies with their different
contributions.
Table 1
exchange
rate risk
2000 Chou W.L Cointegration Real exports Foreign 1981 to Positive link
ARCH, income, 1996 of volatile
ARDL relative exchange rate
prices, with exports
exchange
rate
uncertainty
2004 Mustafa and Cointegration, Real exports Relative 1993 to Negative link
Nishat ADF prices, 2004 of volatile
foreign exchange rate
income, with exports
volatile
exchange
rate
2006 A.C Arize Jarque bera, Exports Foreign 1973 to Negative link
Johansen income, 1993 of volatile
multivariate , relative exchange rate
OLS, Ljung prices, with exports
box, Breusch volatile
Godfrey, exchange
ECM rate
2006 Ozturk ARDL, Unit Exports ER, Imports, 1985 to Significant
root volatile 2004 long-run link
exchange of exports
rate with volatile
exchange
rate.
2006 Fountas and ECM, VAR Real exports Foreign 1979 to Negative link
Bredin cointegration income, 1993 of volatile
relative exchange rate
prices, with exports
volatile
exchange
rate
2008 Oskooee and ECM , F test Exports Income, real 1971 to Negative
Kovyryalova cointegration volume exchange 2003 significant
rate. Volatile link of
exchange volatile
rate exchange rate
with exports
2009 Rahman and Matrix Real exports General price 1973 to Negative and
Serletis approach level, output 2005 significant
level, MS, link of
commodity volatile
prices,funds exchange rate
rate, trade with exports
weighted
exchange
2011 Wong and Tang ARCH, Export Foreign 1990 to Unique long
ARDL, DL, Growth income, 2001 run link
CUSUM, relative among
CUSUMQ, prices, exports
CHOW TEST volatile quantities .
exchange
rate
2014 Gul and 2SLS Demand for World 1990 to Positive link
Rahman exports production 2010 of demand
capability, for exports
Supply of
FDI, NEER, with world
exports
unit value of income and
exports, negative link
NNI, gross of supply of
national exports with
investment, FDI
gross capital
formation,
GDP
2015 Panda and Cointegration, Exports World GDP, 1971 to Negative link
Mohanty standard volume REER, 2012 of Indian
deviation volatile exports to the
exchange volatility
rate
2017 Khalil, Unit root, Exports Research and 1970 to Negative link
Mehmood and ADF, DL, development, 2015 of volatile
Hassan ECM, granger PI, UNEMP, exchange rate
causality test FDI with exports
2017 Ahmed, Qasim ARDL, ECM, Exports GDP, world 1970 to Negative link
and Chani ADF, Philips income and 2015 of volatile
Perron test exchange exchange rate
rate with exports
2017 Barseghyan and Cointegration Real exports Foreign 2007 to Exports and
Hambardzunyan ,ARCH LM income, 2016 Exchange
test Godfrey relative rate
LM prices, uncertainty
volatile shows
exchange negative long
rate run and short
run link.
2018 Camara Kwasi ARDL, Exports GDP per 1983 to Volatility has
Obeng NARDL, diversificatio capita, fixed 2015 symmetric
GARCH, n capital effect on
Cointegration. formation, exports.
inflation, no.
of telephones
lines ,trade
openness,
REER
2019 Nguyen Thi Engel Real exports GDP, REER, 2000 to Negative
Thuy and Trinh Granger Volatile 2014 association of
Thi Thuy ,GARCH, exchange volatile
ARIMA, rate exchange rate
ECM, with exports
Cointegration
There is a contradiction in the previous papers some studies said that there is a positive
association between volatile exchange rate and exports, some showed negative and some said
exchange rate volatility showed no effect on exports.
There is also a contradiction in the studies related to significant and insignificant
variables that is volatile exchange rate related to exports. Because different studies use mostly
different variables according to their country.
3. Methodology:
Theoretical model
The exports is the function of ,inflation, exchange rate and exchange rate volatility .
Economic theory advocates If the price level falls in results the interest rate will also falls
and foreign investment tends to increase, the real exchange rate will depreciate and automatically
the exports will depress. Increase in inflation will increase the exports. Finally the exchange rate
volatility, it depress the exports because it create uncertainty about the future profits to the
exporters. It create risks.
Econometric Model
ln EX = β0 +β1 ln INF + β2 ln ER + β3 ln Vt + μ
This study use the log- log econometric model. In which ln Ex is the natural log of
exports of goods and services, ln INF is the natural log of inflation which is use as a proxy of
CPI, ln ER is the natural log of real effective exchange rate, ln Vt is the natural log of exchange
rate volatility and μ is the error term.
Formula of Volatility:
Where m is the moving average m = 1.15 by taking the simple arithmetic mean of the data
and e the real effective exchange rate used in the formula.
Empirical strategy
Before estimation it is important to detect that whether the stationarity exists or not or at which
level then according to the nature ARDL test is used to detect the long-run and short-run relation
among the variables.
Stationary Test
To inspect the stationarity nature of the variables ADF Augmented Dickey Fuller is used.
Cointegration Test:
Johansen (1988) introduced this concept which is used in more than two series. It detects
the relation of the nonstationary variables in the long-run. It removes all the drawbacks of
granger approach. For short run relationship Johansen introduced an Error Correction model
(ECM). For cointegration it is necessary for the dependent variable to be order of integrated 1
that is I(1)
This paper used the unit root test according to the study’s nature. The ADF test applied
first according to the variables trend and intercept. Schwartz Bayesian Criterion is used for the
selection of lag. The variables ln ex, ln er, ln vt are stationary at first difference but ln inf is
stationary at level.
Table 3
To evaluate the relation exists in short run and long run, for that purpose this paper
applied the ARDL approach. Because the study found the different cointegration orders that
are based on Schwartz Bayesian Criteria. The values of F statistics are greater at 1 % and 5 %.
The coefficient of determination R2 is 97%. It means that 97% variation in the Exports is due to
inflation, exchange rate and exchange rate volatility and remaining 3% is due to other variables
that are not involved in the model. There is no autocorrelation in the model and the model is
good fit. All variables are significant.
c 8.0533 0.025
F statistics Probability
2.9546 0.0000
Critical values of F-statistics
5% 2.1356 2.2775
Bound test are shown in the above table. Probability of F statistics shows
that it is significant. It shows a long run relation because the F statistics is greater than both
bounds at 5 % significance level.
ARDL approach shows a relation in long-run, so the study has imposed a short run ECM. It
expresses a short-run link exists between the variables. Because here condition is satisfied. The
value of ECM lies between 0 and 1 and also negative. Here the value of ECM -0.26 which
means that 26 %. There is 26 % convergence of variable from its disequilibrium t its long run
relationship.
Table 6
Conclusion
The study investigated the interconnection of volatile exchange rate on the Pakistan
exports. Exports is one of the macroeconomic variable that increase the growth of an economy.
Volatile exchange rate is major determinant of exports and is the main factor that reduce the
exports of the country. the volatile exchange rate is the main determinant that determine the
exports of Pakistan. The study determine the impact of exchange rate volatility in the presence of
inflation. The study use the formula of volatility to determine the variable that is volatile
exchange rate. The study use the log-log model.. The study applied the unit root test and after
that it applied the ARDL approach. The study found a significant and negative long run relation
exist between the exports and volatile exchange rate. The study also found a significant and
negative short run relation between exports and volatile exchange rate by ECM approach.
Policy recommendation
If the level and stability of exchange rate is ignored by policy makers then it create uncertain
results in the stability of the trade market.
The Bank reserves should monitor in such a way that whenever the volatility will reach at
particular, or specific level it will moderate the volatility.
There will be a little increase in the volatility, if firms operate in an open economy that should be
small.
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