Analysis of exchange rate fluctuations and external debt: Empirical evidence from Pakistan

Abstract

The primary purpose of this study is to examine the relationship, with respect to the Pakistani economy, between exchange rates and external debt by utilizing quarterly data from the 1983:Q1 to 2008:Q4 period. Short-run and long-run nominal and real effective exchange rates and their respective equilibrium rates have been assembled. The long run equilibrium exchange rate has been determined by employing the natural real exchange rate (NATREX) model suggested by Stein et al. (1990). We applied the Johanson (1988) cointegration test to examine the long run cointegration relationships among exchange rates and the relevant exogenous variables in the Natrex model. After computing the deviation of exchange rate from its long run, the autoregressive distributive lag model (ARDL) was applied to examine the role of external debt in the fluctuation of exchange rate. The results suggest that there is a long-run cointegration relationship among the relevant variables in the Natrex model and there is a long run cointegration relationship between the exchange rate and external debt variables. We also checked the stability of the functions and performed diagnostic tests. Most of the tests suggested that the functions adopted for the analysis are appropriate and stable over time. Moreover, the obtained results are robust and in according to the predictions of the model. Key words: Exchange rate, external debt, autoregressive distributive lag model (ARDL), methodology.