Exploring the impact of exchange rate volatility on trade balance: Evidence from Pakistan and its major trading partners

Abstract

The present research delves into examining the impact of fluctuations in the exchange rate upon the trade balance of Pakistan, as well as on that of its major trading partners such as the United States, China, the United Kingdom, Saudi Arabia, Japan, Germany, Malaysia, and Singapore. The present study obtained data for the purpose of analysis from two reputable sources, namely the World Development Indicator (WDI) and the International Trade Centre (ITC). The timeframe under investigation ranged from 2003 to 2021. Trade balance is dependent variable and volatility of exchange rate, Gross Domestic Product (GDP), and Inflation serve as independent variables. To measure these correlations, the research utilizes the Panel Autoregressive Distributed Lags (PARDL) model. In the short term, Exchange rate and Consumer Price Index (CPI) doesn't seem to have a significant impact on Trade Balance, while the natural logarithm of GDP demonstrates a statistically significant and positive impact on Trade Balance. In the long run, the study found a significant positive link between exchange rate volatility and Pakistan's trade balance. Currency devaluation was observed to enhance the trade balance, with a one-unit increase in volatility leading to a substantial 6.23% annual trade balance improvement. Additionally, the long-term trade balance dynamics were influenced by positive effects from Ln(GDP) and a negative impact from inflation. In a net shell, the focus of this study to explore the long-run relationship.