Exchange Rate Fluctuations in Pakistan, Causes and Remedies

Abstract

Exchange rate plays a crucial part in the development of the country and it highlights the prosperity of the country's economy. This study takes various set of determinants, which affect the instability of rate of exchange in the country. This study investigated the relationship of interest rate, inflation, Forex, trade balance and inflow of net foreign capital with exchange rate. The study analyzed the data for the period 1972 to 2014 for Pakistan. Multi-level statistical estimation techniques, VECM, Johnson co-integration, impulse response, variance decomposition and granger causality are applied. The results demonstrated long relationship of interest rate, trade balance, foreign exchange reserve, net foreign capital inflow and exchange rate. The study also confirmed the positive effect of these variables on exchange rate. The study can be especially significant for the government, to make appropriate action to better deal with exchange rate volatility. Keywords: VECM, Granger Causality, Instability of Exchange Rate, Pakistan.