REAL AND ILLUSORY ASPECTS OF AN OVERVALUED EXCHANGE RATE:THE PAKISTAN CASE 1

Abstract

IT is well recognized that a system of offsetting export subsidies and import tariffs is a substitute, in the sense of producing the same trade effects, for a change in the official exchange rate. In fact, there exists an infinite set of combinations of official exchange rates, coupled with tariffs and subsidies, which can produce the same effective exchange rate.2 What is not so widely recognized is that in a country where foreign trade is significant and where there are large inflows of foreign resources, the levels of several financial flows, important from a planning and government policy point of view, are highly sensitive to alternative choices of a nominal exchange rate with the appropriate offsetting subsidies and taxes. This paper shows, for the year 1964/5,3 the pattern of direct resource transfers, the government budget, and domestic resource mobilization, which would emerge in Pakistan when financial flows are measured using alternative exchange systems having the same effective exchange rate, and hence the same structure of relative prices and resource use, but which have different nominal or 'official' exchange rates. Also, average and marginal savings rates are calculated for various time periods, using the alternative exchange systems. The calculations presented demonstrate the extent to which one 's view 1 This paper was initiated while the author was at the Economic Growth Center at Yale