REER as a Measure of Exchange Rate Misalignment
The exchange rate is considered as a measure of a nation’s relative success in the external sector. For example, an appreciation of the currency rate indicates that a country has performed better than its competitors, and vice versa. However, this measure is applicable under flexible exchange rate regime, where the exchange rate is determined by market forces. According to IMF’s report on Exchange Rate Arrangements, only 29 countries in the world are following purely flexible exchange rate regime and rest of the countries are following Managed Float exchange rate regime (Poirson, H. ,2001). In managed float, exchange rates are controlled by SB’s direct and indirect interventions in the foreign exchange market, which leads to undervaluation or overvaluation of exchange rate.
Exchange Rate Regimes in Pakistan
- Pakistan remained under fixed exchange rate regime till 1981.
- Adopted managed float in 1982.
- Adopted market based exchange rate in 1999, but never allowed exchange rate to take its market value.
Is Pakistani rupee overvalued?
Over the past five years, PIDE’s research on the exchange rate has focused on uncovering the complexities of currency devaluation and the uncertainties surrounding Pakistan’s foreign exchange market. By exploring key issues such as depreciation, undervaluation, the effect of exchange rate fluctuations on prices, and the onset of currency crises, the research provides valuable insights into how exchange rate policies can shape economic outcomes.
In Pakistan, the exchange rate policy has always tended toward overvaluation due to SB continuous intervention in the foreign exchange market. SB, continuously supporting the overvalued exchange rate at the cost of depleting foreign exchange reserves (see Figure 2) even in the market based exchange rate regime.
