Impact of exchange rate volatility on sectoral exports of Pakistan: an ARDL investigation
| Pages | 215-231 |
| DOI | https://doi.org/10.1108/17544401211263973 |
| Published date | 28 September 2012 |
| Date | 28 September 2012 |
| Author | Muhammad Aftab,Zaheer Abbas,Farrukh Nawaz Kayani |
| Subject Matter | Economics |
Impact of exchange rate volatility
on sectoral exports of Pakistan:
an ARDL investigation
Muhammad Aftab
Department of Management Sciences,
COMSATS Institute of Information Technology, Islamabad, Pakistan
Zaheer Abbas
Faculty of Management Sciences, International Islamic University,
Islamabad, Pakistan, and
Farrukh Nawaz Kayani
Department of Management Sciences,
COMSATS Institute of Information Technology, Islamabad, Pakistan
Abstract
Purpose – The purpose of this paper is to explore the impact of exchange rate volatility at sectoral
level on the exports trade of Pakistan. All the sectors involved in the export trade (proposed by the
State Bank of Pakistan, by commodity), were used to study this relationship at a more minute level.
Design/methodology/approach – Quarterly data regarding research were collected over the
period 2003 to 2010 from databases of State Bank of Pakistan and International Monetary Fund
financial statistics. The bound testing approach proposed by Pesaran et al., was used to study the
relationship between sectoral export and exchange rate volatility, while augmented Dickey Fuller
(ADF) and Phillips Perron tests were used to test the unit root of series and GARCH,proposed by
Bollerslev, was used to study exchange rate volatility.
Findings – The results show that exports are negatively influenced by exchange rate volatility and
relative prices while positively affected by foreign income. This relationship holds for all sectors where
bound testing revealed the existence of long- run relationship, although some equations results were
not statistically significant.
Practical implications – The paper’s findings can be used to form such policies which result in a
stabilized and competitive exchange rate, so that Pakistan’s exports can be increased.
Originality/value – Previous studies have been conducted on aggregated data set for exports in the
Pakistani context, which hinders pertinent information; however this information is possible by
studying disaggregated data. The paper fills a research gap by taking sectoral level data, to divulge
the behavior of individual sectors against exchange rate volatility.
Keywords Pakistan, Nationaleconomy, Exports, Exchangerates, Econometrics, Exports trade,
Exchange rate volatility, Augmented Dickey-Fuller test
Paper type Research paper
1. Introduction
After the downfall of the Bretton Wood fix exchange regime in the early 1970s, major
economies of the world started to move their regimes from a fix to float exchange rate
system. This shifting has attracted tremendous attention of researchers with their prime
aim to investigate the effects of this new regime shift on trade. The general view that
exchange rate movements reduce trade has resulted in the formations of monetary
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1754-4408.htm
Sectoral exports
of Pakistan
215
Journal of Chinese Economic and
Foreign Trade Studies
Vol. 5 No. 3, 2012
pp. 215-231
qEmerald Group Publishing Limited
1754-4408
DOI 10.1108/17544401211263973
unions like the European Union monetary unification and also motivated the centr al
banks to intervene in currency markets (Bayoumi and Eichengreen, 1998).
Microstructure models based on a theoretical background propose the negative
relation between exchange rate movements and export trade (Barkoulas et al., 2002).
This is the one side of the coin which is quite simple; the other view of research is very
ambiguous with no clarity. Behavioral models suggest that this ambiguity is due to
different attitudes of export traders, the loss averse traders take exchange rate risk as a
substitution effect and they shift their trade investment from international to local
markets while the more risk averse investors take it as an opportunity for income effect
and they increase their trade to offset expected downfall in revenue. The empirical
research suggests that the difference in results on exchange rate effect on trade in
research is due to different methodology, sampling periods and scenarios in studies.
Another argument is that investors’ hedge exchange rate risk in short run horizons but it
is costly in long run (Pour and Moghaddasi, 2010). Short term exchange rate risk is easy
to manage and cheaper while long run exchange rate is tricky and has a very deep effect
on trade (Cho et al., 2002) and is also costly to mitigate short run risk, even in the presence
of hedge instrument due to the expensiveness of forward exchange rate with high risk
premium, thus exchange rate risk effects cannot be eradicated (Vianne and De Vries,
1992). For developing countries hedging is very unsatisfactory and costly and especially
for smaller companies which may face financial distress (Doroodian, 1999; Wei, 1999).
Exchange rate is a topic of much interest for researchers particularly for researchers
in developing countries as it connects the domestic market to the rest of the world,
being relative price and also defines the exchange power of a country (Aliy u, 2010).
It provides a cushion for internal and external balances over a long run time period.
However, its deviation from equilibrium affects economy severely, although it is still
confusing what determines the equilibrium rate but there is increasing agreement in
literature that its disequilibrium is not healthy for an economy (Aliyu, 2010). The
prolonged exchange rate risk makes firms’ attitude risk averse to trade, thus it
negatively affects the trade (Anderton and Skudelny, 2001). However, studies show
insignificant negative impacts of exchange rate volatility on trade which is not robust
and even empirical and theoretical studies are not able to conclude that exchang e rate
stability promotes international trade (Hayakawa and Kimura, 2009).
Exchange rate risk study is of very prime importance for those countries which have
swapped their regime from fix to float (Ariz et al., 2008). The study of this phenomenon
increases the understanding of exchange rate movements. Pakistan, after a decade of
struggle to move with the pegged regime, finally decided to adopt the float exchange rate
in 1982. In the early 1980s the Pak Rupee was branded to manage float and was pegged
with the US dollar as chief anchor currency besides another basket of currencies. In 1998,
Pakistani authorities embraced the multiple exchange rate system to avoid financial
crisis due to nuclear endeavors, so at that time Pakistan had three rates, e.g. official rate
pegged with US dollar, floating interbank rate and a combination of these two rates
(Composite rate). After recovery, these three rates were merged to one that was pegged
with the US dollar under a certain band. In 2000, the band was removed and now
Pakistan is maintaining float rate, although the intervention of the central bank is still in
question. The preceding studies found this decision very prudent and in favor of the
broader interests of economy. One prominent study about the right exchange rate
regime for Pakistan is Husain (2006). He investigated comprehensively the key
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