Impact of Devaluation on Pakistan's External Trade: An Econometric Approach

Abstract

Exchange rate policy to improve external competitiveness has now become the centre piece of any adjustment effort. It is expected that a nominal devaluation will result in expenditure switching, increased production of tradeable, higher exports, and in an improvement of the external accounts of the country in question. Recently, the traditional stabilisation packages, and especially their devaluation component, have come under attack by a number of authors.! It has been argued that devaluation can be counterproductive because exports and imports are relatively insensitive to price and exchange rate changes, especially in developing and semi-industrialised countries.2.3 If the price elasticities of imports and exports are sufficiently low, the trade balance expressed in domestic currency may worsen. Grubel (1976) has argued that a country's persistent payments imbalances can be due only to faulty monetary policy and cannot be corrected by either devaluation (exchange rate policy) or the use of fIscal policy. In a recent article, Miles (1979) claims to have provided the requisite evidence to support Grubel's argument. Miles (1979) shows that devaluation does not improve the trade balance but improves the balance of payments. This results implies that the improvement comes through the capital account.