Exchange Rate Dynamics and its Misalignment: A Case of Pakistan

Abstract

This paper is an attempt to investigate the long-run real exchange rate and its misalignment in the case of Pakistan from 1978 to 2018. The model based on previous theories to calculate the real exchange rate of equilibrium rooted on several macro-economic variables (Montiel 1997). After exploring the presence of a stable relationship between variables, the long-run effects of these variables on the RER balance and the short-run dynamics are calculated. The study looked at a persistent overvaluation in RER from 1978 to 2018 in Pakistan, except for 1986 to 1995, which is 21.86 percent in 2018 and is calculated using the misalignment index. This overvaluation is one of the main reasons for Pakistani exports to decline in economic performance and lose competitiveness in international markets. In order to improve the external sector, this study recommends that the competent authorities should adopt a rational exchange rate policy to strengthen the economy.