Correction of Trade Deficit through Depreciation – A Misdirected Policy: An Empirical Evidence from Pakistan 

2020:24

The favorable trade balance is a good indicator for developing economies. But the correction of trade deficit through depreciation of exchange rate is a misdirected policy tool. This study clears this misperception by measuring the elasticity of exports, imports and balance of trade with respect to real exchange rate in Pakistan. Further, it also investigates whether trade elasticities are sensitive to different trade regimes and exchange rate policies during time period from 1982 to 2019. The Johansen et al., (2000) structural break cointegration technique is applied for analysis. The results reveal that devaluation is not good for boosting the demand of exports but it increase the demand for imports and ultimately deteriorate the trade balance. Therefore, study rejects the existence of J-curve in Pakistan. Therefore, exchange rate policy can do nothing on the structure. In fact, the need for a devaluation is the inefficiencies in the structure of the economy.