Recommendations to stabilize the exchange rate in Pakistan

Introduction.

Exchange rate is the price of one currency in relation to another. In another perspective it is defined the national currency’s equation to foreign ones. It is a conversion factor, a ratio and multiplier but it is depending in the direct of conversion when exchange rate move it may turn out to be moving price in the economy and on foreign goods as well. Volatility is defined as uncertainly, instability and measure of risk, in asset pricing, option pricing and risk management which included a Varity of economic decisions.

Volatility of exchange rates defined uncertainly in international transactions in goods and financial assets. Exchange rates are modelled as forward looking relations asset prices that reflect unanticipated change in relative demand and supply of domestic and foreign currencies, so exchange rate volatility reflects agents expectations of change in determinates of money supplies, interest rates and incomes.

According it the movement of exchange rates developing countries do changing development strategies and implementing changes in development strategies. the alteration in exchange rate have an effect on economic growth and needs to investigate what extent exchange rate volatility may be the responsible for variation in the rate of economic production because these moves are accompanied by increase in the volatility of both nominal and real exchange rates(Caporal and Pittis 1995)

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Instability of exchange rate can have negative effects on foreign and domestic investment decisions of a country. It leaves effect on resources among the sectors and countries imports and exports. Secondly it creates an instable environment for investment. These are two different macroeconomic theories which describe how exchange rate volatility affects on domestic & foreign investment.

How the domestic economy respond to domestic foreign and monetary shocks under the different exchange rate regimes.

How volatility exchange rate under flexible exchange rate regime affects international trade.

The mobility of capital an economy that is affected by shocks to the LM curve, due to changes in money demand. if exchange rate is flexible it brings big fluctuations in inflation, output on the other hand if exchange rate is fixed then capital is internationally mobile then the money supply is endogenous-change in money demand determine change in the money supply so that LM shocks will have no effect on output or inflation. In some developing countries that peg their exchange rate achieve lower inflation than those whose exchange rate floats (Obstfels 1995.Bleaneg and Fielding 1999.Ghosh etal 1995. Alogoshoufis 1992)

The most important reason for devaluation to trigger an aggregate demand contraction include redistribution of income towards those with high marginal, propensity to save, a fall in investment, an increased debt burden, reduction in red wealth, a low government marginal propensity to spend out of tax revenue, real income declines under an initial trade deficit, increased interest rates and increased foreign profit.(Cooper 1971a.1971b,1971c.Vanwijnbergen 1986.Hanson 1983.Gylfason,Radetzki 1991.Barbone and Rivera-Baits 1987.Krugman and Taylor 1978)

According to another approach aggregate supply may suffer after devaluation because if more expensive imported production inputs, costlier working capital ,wage indexation programmes(Hanson 1983.Branson 1986.Wijnbergen 1986 and Edwards 1989b.Bruno 1979.Gylfason and Schmid 1983)

It is the level of volatility increase in the exchange rate it leaves the negative effect on short run and long run export demand also it may effect on relocation of sources by market participants, so it is useful move to flexible exchange rate fixed exchange rate because it gives the higher degree of variability associated with flexible exchange rates. (Coes 1981 .Baum et al 2001.Brada and Mendez 1988. Hooper and Kohlhagen 1978.Grauwe 1988)

The volatility of exchange rate impact on investment and hence n economic growth is not a recent source of concern. Instability reduces investment in the presence of adjustment costs and when the investment process includes irreversibility’s real exchange rate instability creates an instable environment for investment decisions and investors takes time to make up their mind to take investment decisions. They try to get more information about the real exchange rate if investment is irreversible and exerts negatively on economic performance .Campa and Goldberg 1993 found a negative impact of exchange rate volatility on investment.

Aiznman 1992 found positive relationship while Campa and Goldberg 1995 found almost no effect.

Volatility exchange rate can effect on longer term decisions by affecting the volume of primary exports. The investments and government policies. In other sense it effects on the balance of payments and economic activities, while in the short run local consumers and the primary export can be affected.

Exchange rate volatility helps to investors to invest in foreign currency to get higher returns and foreign currency will strong against home currency. In this situation it is directly impacts the prices of primary export commodities and the growth rates. The investors always favour the system where the variance of the different between expected and actual value of exchange rate is minimised, investors and traders prefer volatile exchange rate so that they can maximise their profits because of high risk premium on the other hand volatility of exchange rate can have positive impacts on primary exports.

Hooper and Kohihagen 1978 found negative association between exchange rate volatility and volume of trade but found positive association with exports prices when exporters bear the exchange risk and negative impact when importers bear the risk. According to the Lanyi and Suss 1986 exchange rate variability affects on prices of export and domestic currency which is interlink with the international transaction. Mostly exchange rate volatility should have negative impact in trade by increasing the risk of international trade activities (De Grauwe 1988.

In this situation risky investors try to increase exports to avoid the possibility of decline in their revenues but less risky investors or neutral investors are less worry with extreme outcomes. According to this relationship hypothesis is developed relating to the link between volatility of exchange rate and macro economic growth.

It is considered an opportune time for such analysis because more and more countries are considering revisions in their exchange rate arrangements. Here is a direct link between exchange rate volatility and macro economic performance in the presence at open economics. The aim of this study is to find out the nature of this relationship like negative or positive or even insignificant.

1.2

Objectives:

To analysis exchange rate volatility in Pakistan, 1947 to 2005.

To identify the importance of real exchange rates for both Pakistan’s domestic & foreign investment.

To critically evaluate Pakistan’s monetary policy and its effects on primary exports.

To make recommendations to stabilize the exchange rate in Pakistan.

1.3:

Methodology:

Research is important both in scientific and non-scientific fields. Modern research efforts depict a plethora of methodologies, literature and themes to research abundantly and thoroughly (Bryman, 2001) though with as many varieties in underlying assumptions and orientations as to what exactly constitutes knowledge. Research methodology depends upon the author’s willingness and nature if the problem affects whether the research is going to be exploratory, descriptive or casual (Eriksson & Wiedersheim- Paul 1997, Quoted by Caroline) In this research study the Explanatory/Causal Research will use for identify the cause and effect of exchange rates volatility on macroeconomic performance of Pakistan in respect of domestic & foreign investment and effect on Pakistan’s primary exports. According to Zikmund (1994), Explanatory research approach is use to identify cause – effect relationships between variables. Exploratory and descriptive research normally precedes cause and effect relationship studies.

Qualitative and Quantitative Research Approaches:

Qualitative Interest Group of Market Research Society (1992, quoted by chistan 1997) says that qualitative research to be a wide-ranging technique encompassing many different approaches and can range from large time consuming Government social research contrasts to pre-testing of consumer advertising. According to Chisnal (1997) the essence of qualitative research is that it is diagnostic, it seeks to discover what may account for certain kinds of behaviour. According to Malhotra (1996) qualitative research is an unstructured, exploratory research methodology based on small samples that provides insights and understanding of the problem setting. Quantitative research seeks to quantify the data and typically applies some form of statistical analysis (Malhotra 1996).In this research study will use both research approaches for analysis the data.

The typical differences in both the approaches can be seen below

Qualitative Research

Quantitative Research

Objective

To gain a qualitative understanding the reasons of Volatility of exchange rates and effect on Pakistan’s primary exports.

To quantify the data find out the results from different methods.

Resources

Secondary

Secondary

Data collection

Unstructured.

Structured

Data analysis

Non-Statistical.

Statistical

Outcome

Develop an initial understanding

Recommend a final course of action.

Figure 1.2 Qualitative vs. Quantitative Research, Chisnal (1997, P-164

In this research study the data is collected from the secondary sources and analyze the data, trends of exchange rate volatility and impact on domestic & foreign investment in Pakistan and primary exports of Pakistan. In this research study will discuss the changes in the primary exports of Pakistan, Pakistan’s monetary policy, foreign exchange reserves, manufacturing products, domestic & foreign investment. The data regarding these are collected from various published sources etc.

Resources of Secondary Data Used:

Articles which can be download from the internet.

Published market research reports.

Government organizations websites.

Publications in libraries including online libraries.