Currency Devaluation and its impact on the Economy with respect to Pakistan. 4

1. INTRODUCTION & ABSTRACTThe purpose of this paper is to determine and analyze the relationship between devaluation of countrys currency and its impact on the economy. Devaluation is a reduction in the value of a currency with respect to other monetary units. OR Devaluation means decreasing the value of nations currency relative to gold or the currencies of other nations. Devaluation occurs in terms of all other currencies, but it is best illustrated in the case of only one other currency, it specifically implies an official lowering of the value of a country's currency within a fixed exchange rate system, by which the monetary authority formally sets a new fixed rate with respect to a foreign reference currency. The question arise here is why government devalue their currency, and the reason behind is to encourage export and discourage import. A devaluation means that more local currency is needed to purchase import and exporter get more local currency when they convert the export proceeds, in this way import becomes more expensive and exporter will earn more money hence reduce trade deficit. In this paper we will compare Pakistani Rupee against the US dollar and analyze impact of the changing exchange rate on some economic factors of Pakistan.This is very important to know that whether devaluation of currency could affect the some particular economic factor of a nation, if yes then to what extent. In this paper I have considered three dependent variables which are Trade Balance, GDP and Inflation, on the other hand one independent variable which is Pak Rupee exchange rate against dollar. The data is gathered from State Bank of Pakistan & Federal Bureau of Statistics for the fiscal year 1980-1981 to 2009-2010. To determine and analyze the relationship between independent and dependent variables I have used Linear Regression Analysis and found that there is a significant relationship between exchange rate & trade balance hence we reject the null hypothesis and accept the alternate hypothesis, although the value of adjusted R-Square is only 0.365 means the exchange rate predict trade balance with only 36.5 % accuracy which is moderate. The scatter plot does not follow any pattern which shows the adequacy of the fitted model. The other two dependant variables have found insignificant relationship with exchange rate.2. LITRETURE REVIEWA few numbers of studies have reviewed to determine and analyze the relationship between the independent & dependent variables. Waliullah, Mehmood Khan Kakar, Rehmatullah Kakar & Wakeel Khan (2010). This article is an attempt to examine the short and long-run relationship between the trade balance, income, money supply, and real exchange rate in the case of Pakistans economy. Income and money variables are included in the model in order to examine the monetary and absorption approaches to the balance of payments, while the real exchange rate is used to evaluate the conventional approach of elasticity (Marshall Lerner condition). The bounds testing approach to co-integration and error correction models, developed within an autoregressive distributed lag (ARDL) framework is applied to annual data for the period 1970 to 2005 in order to investigate whether a long-run equilibrium relationship exists between the trade balance and its determinants. The result of the bounds test indicates that there is a stable long-run relationship between the trade balance and income, money supply, and exchange rate variables. The estimated results show that exchange rate depreciation is positively related to the trade balance in the long and short run. The results provide strong evidence that money supply and income play a strong role in determining the behavior of the trade balance.Sulaiman D. Mohammad & Adnan Hussain (2010). Objective of this study is to estimate the impact of real exchange rate depreciation on balance of trade in Pakistan. The study examines validity of the Marshall Lerner condition in Pakistan data (1970-2008) by using impulse response function which fulfills the J- curve idea. To evaluate long run association among the variables by employing Johansson Co integration test. The end consequence of test shows that there is long run relationship among the variables at vector two.Huseyin Kalyoncu, et all. (2008). This article studies the effect of currency devaluation on output level of 23 OECD countries. All data are quarterly and gathered from the International Monetary Funds International Financial Statistics (IMF-IFS) database. The author uses unit root and co integration test, to develop a simple model to test the devaluation-output growth relationship. In order to test devaluation output growth relationship two variables are constructed. These variables are real exchange rate (rer) and real GDP (Y). Real exchange rate is defined as nominal exchange rate times the ratio of US price index to the domestic consumer price index. The nominal exchange rate is defined as the price of the domestic country in terms of the US dollar (domestic currency/US dollar). The empirical evidence suggests that, in the long run, output growth is affected by currency devaluations in 9 out of 23 countries. In six out of nine countries, depreciation exerts a negative impact on output growth; however depreciation improves output in three countriesMunir A. S. Choudhary & Muhammad Aslam Chaudhry (2006). This paper studies that whether devaluation of currency effect the output & price level in Pakistan from the period 1975 to 1985 and to analyze the impact the authors used VEC model and suggest that both increase in import price and devaluation has short term effect on output and adverse effect on the price level for Pakistan economy.Ehsan U. Choudhri and Mohsin S. Khan (2002). This paper challenges the popular view that devaluation of the rupee is inflationary and re-examine the evidence for Pakistan and present new results, which demonstrated that rupee devaluations have had little impact on inflation. The data gathered from Pakistan during the period 1982 to 2001 to examine whether inflation is systematically related to changes in the exchange rate. The empirical tests are conducted to find out whether or not devaluation leads to an increase in prices and finds no association between rupee devaluations and inflation in Pakistan. The paper finds no evidence of a significant pass-through of rupee depreciations to consumer prices in the short run. It would appear, therefore, that concerns about the inflationary consequences of devaluation in Pakistan are somewhat misplaced. It appears, therefore, that concerns about the inflationary consequences of rupee devaluation are unsupported by the facts. Eduardo Borensztein & Jos De Gregorio (1999). This paper has examined the response of inflation after currency crisis for Asian countries and construct a sample of currency crises that ended with a large depreciation of the domestic currency in the 1970-1996 period. This paper does not address the devaluations, and its effects on inflation. 3. METHODOLOGY

To test the relationship between independent variable which is Pakistani Rupee against the US dollar and dependents variable that are Trade balance, GDP & Inflation I have used Linear Regression Analysis by the help of 30 observation for each variable.4. ANALYSIS

First of all I have taken Exchange rate as a Independent variable and Trade Balance as dependent variable and run regression test and found that there is significant relationship between them and that is why I have reject the Null hypothesis and accept the Alternative hypothesis. The R-value, which represents the correlation between the observed values and predicted values of the dependent variable. R-Square is called the coefficient of determination and it gives the adequacy of the model. Here the value of R-Square is 0.365 that means the independent variable in the model can predict 36.5% of the variance in dependent variable because there are also many other factors which can affect the values of Trade Balance. Adjusted R-Square gives the more accurate information about the model fitness. The histogram of standardized residuals shows the value of mean and standard deviation of the residual in the model. The mean and standard deviation is approximately 0 and 1 respectively, which shows that the fitted model is best and the chances of error is minimum. The Normal probability plot of regression standardized residual shows the regression line which touches maximum number of points presents in the model and it also shows the accuracy of the fitted model and the scatter plot also shows the adequacy of the fitted model as we can see that the data is scattered and it does not follow any particular pattern, so we can say that the fitted model has minimum chances of error. The other two independent variables have found insignificant relationship.Model Summary(b)

ModelRR SquareAdjusted R SquareStd. Error of the Estimate

1.622(a).387.3654.06069

a Predictors: (Constant), Dollor Rate

b Dependent Variable: Trade BalanceANOVA(b)

ModelSum of SquaresdfMean SquareFSig.

1Regression291.5981291.59817.684.000(a)

Residual461.6972816.489

Total753.29429

a Predictors: (Constant), Dollor Rate

b Dependent Variable: Trade Balance.

4. CONCLUSIONDevaluing currency is not the way to improve the economy for developing countries like Pakistan whose imports are very crucial to run the country and whos exports are inelastic. Devaluation is not a stable way to improve the economy, unless the Government revises its method of economic planning and execution of plans, no amount of devaluation will stabilize the external value of our currency. We must give highest priority to the consolidation of our economy via expansion. A strong discipline should be exercised over all the unproductive expenditure whether it is in public or private sector.The devaluation may also hurt the many companies that have heavy debts denominated in foreign money. It can make the economy slower, with growth falling and people may become worried. Exports may go down sharply and the nation may face budget deficit. The stock market may dip to low, the trade deficit may rise and bad property loans may bring crises to financial institution. Accompanying the currency devaluation, the bank has to raise a key lending rate by some percentage to guard against a surge in inflation which can be a threat for the economy. By requiring more currency to buy a dollar, a weaker currency could raise the cost of imports. Devaluing currency means devaluing the price of labor and talent in the international market that send foreign exchange through home remittance. Devaluation will make lose Pakistan heavily both as seller and as a buyer and will make no good substitute for remedial changes in economic policies and developmental planning.5. RECOMMENDATIONS.Developing Countries including Pakistan should first find out the factors that jeopardize its economy. Some factors can easily identifiable in case of our country Pakistan we should improve our tax collection system and imposes taxes on landlords rather that general public. Electricity is also the major bottleneck which prevents our economy to flourish, due to shortage of electricity our industries are facing production problem we can not produce export quality goods which result in negative balance of payment and lower GDP. Encourage people to get education and prevent brain drain and used our human talent in most effective and efficient way.By reducing import we can have positive balance of payment which really boosts our economy. We are still using outdated farming mechanism with modernization, growth could be doubled and export earnings could make a big leap. Almost half of the fruits and vegetables go bad by the time they reach consumers. Warehouses, refrigeration and storage facilities should be the first priority to increase export of these items. The potential of fish farming remains unexploited. Funds should be made available for fish farming & foreign experts should be hired to groom the locals.6. REFERENCES.Huseyin Kalyoncu, et all. (2008) Currency Devaluation and output Growth: empirical evidence from OECD countries, International Research Journal of Finance and Economics.Ehsan U. Choudhri and Mohsin S. Khan (2002). The exchange rate and consumer price in Pakistan: Is rupee devaluation inflationary. The Pakistan Development Review.PAGE 4