Bilateral trade between Pakistan and her trading partners: The effect of exchange rate on trade balance

It has been observed that following a depreciation of the real exchange rate, a country's trade balance may immediately deteriorate in the short run before showing any positive long run effects. This phenomenon is referred to as the J-curve hypothesis in the literature. Previous studies for Pakistan have used aggregate trade data in order to find support for this hypothesis. This study goes one step further by employing disaggregated bilateral trade data between Pakistan and her major trading partners. The main objective is to investigate both the short run and long run effects of real depreciation of Pakistani Rupee on her trade balance with major partners. An autoregressive distributed lag approach to cointegration within an error correction modeling framework has been employed for empirical analysis. An empirical estimation of the J-curve can provide important information about the extent of effects of devaluation and can help direct economic policies pertaining to exchange rate and foreign trade.