Determinate Of Pakistani Forex Exchange

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02 Nov 2017

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Determinate of Pakistani Forex Exchange

Introduction:

  

There has been a long-standing interest in studying the factors that are responsible for uneven vacillation in the stable growth of the world economies. Lots and lots of theoretical literature and empirical evidences have addresses this issue in the past. Hike in prices of goods and services and foreign exchange are two important aspects which are deemed responsible for such potholed fluctuations in the economic growth.

For most of the twentieth century, exchange rates have been fixed by government action rather than determined in the marketplace. Before World War I the values of the world's major currencies were fixed in terms of gold, while for a generation after World War II the values of most currencies were fixed in terms of the U.S. dollar. However, some of the world's most important exchange rates change frequently.

Equilibrium in exchange rate is determined in the foreign exchange market at a point where demand for and supply of foreign currency equates. Demand for a currency comes from net export while supply of the currency comes from net foreign investment. Any change in demand for and supply of currency effect its value just like a good market that is if demand for a currency increases its value (exchange rate) will be increased while increase in supply of the currency will reduce its value(exchange rate) in the foreign exchange market.

Pakistani rupee was linked with British Pound Sterling till 1970 but in 1971 it was linked with US dollar because of the increasing influence of US in the region. Until 1982, The Pakistani Rupee was pegged to the US Dollar. The currency depreciated by 38.5% from 1982-1988, when the government of General Zia-Ul-Haq convert it to Managed float, and again depreciated as a result of bad relationship with donors agencies and trade partners due to nuclear test in 1998.

The empirical studies relating to the link between exchange rate variability and its factors are not conclusive. Exchange rates are basically the prices of one currency in terms of other currencies driven by the normal forces of supply and demand. There are a fixed number of Euros, Dollars, Yen, etc issued at any given time (although governments can and do print extra money to buy other currencies and impact their currencies value). As the demand increases or decreases for any single currency, it drives the clearing price for that currency.

Zada (2010) studied the factors affecting exchange rate of Pakistan for the period 1979 to 2008. The study used multiple regression model in which exchange rate was taken as dependent variable while Inflation, interest rate, Foreign exchange reserves, trade balance, money supply and Gross Domestic Product were the independent variables. The study showed that Inflation, interest rate and foreign exchange reserves strongly influence the exchange rate and remained significant at 1% level while other variables GDP, Money supply and trade deficit remained insignificant.

Hussain and Farooq, (2009) analyzed the effects of exchange rate fluctuations on macroeconomic variables for Pakistan for the period of 1982 to 2007.they used quarterly data and concluded that exchange rate volatility, exports of country and reserve money possess long run positive relationship to the growth of economy. Khan and Sajid, (2005) used the data from 1982-II to 2004-IV to identify both short term and long term relationship of real money balances, rate of inflation, rate of interest both in foreign and at home and real effective exchange rate for Pakistan.

Ahmed, Ara and Hyder (2005) used structural vector auto regression (VAR) model and found that external shocks are important in driving economic fluctuations in Pakistan and their importance has increased since September 11, 2001. The primary source of external shocks is foreign remittances. They found that terms of trade shocks appear to have very little effect on Pakistan’s real exchange rate, domestic output, and domestic prices. However, because the volatility of these shocks is relatively high, they do explain a non-trivial proportion of the fluctuations of these variables, especially the price level, around the baseline. Foreign output shocks lead to a real depreciation of the

rupee but their spillover effects on domestic output are rather modest. By contrast positive shocks to remittances from abroad lead subsequently to a significant increase in domestic output and a substantial real exchange rate appreciation .

Galati and Ho (2003) showed that news play a role in fluctuation of exchange rate for Euro and dollar.The results of the study showed that good news bring appreciation while bad news depreciates currency.

Sanchez-Fung (2003) also studied the same relationship and stated that exchange rate is more responsive in case of depreciation.

Xiaopu (2002), MacDonald and Ricci (2003)studied the long term determinants of real exchange rate are Openness of an economy, capital flows and terms of trade.

Ejaz, Abbas and Saeed (2002) showed a direct relationship between exchange rate and budget deficit under the managed floating exchange system. Their study covered the period of 1982 to 1998 for Pakistan. It is proved that budget deficit is also playing an active role in determining real exchange rate in Pakistan. In the present study different choices were included to find out the interaction of exchange rate and exogenous factors.

The FDI's most important determinant is Income for the outflows of Germany. The influential factor i.e. the exchange rate was also discovered by them for its effects on Singapore and Brazil's outward FDI. On the other hand, a higher outward FDI can be gained by a low interest rate in their home country. A better financial support is essential to invest abroad and increased capital allows the firm to access the capital market in term of low interest. This can help the firms to have the needed finances for their investments abroad. Also, outward FDI is also affected by the exchange rate. Firms that belong to the countries that have a higher currency rate will discourage exports as compared to the firms that belong to the countries of lower currency rates. And this may lead to a higher proportion of making investments abroad because of the favoring of currencies. Jerome Swee-Hui Kueh, et all (2009).

An important determinant is exchange rate in case of inflation when it comes to Malaysia. And India holds money supply as the broad term (M2) as important. At the same time money supply hold less importance for Japan but South Korea holds exchange rate as an important factor for inflation. While for Pakistan the important factor in inducing inflation for the country is money supply. Paul (1997).

Massive speculative pressures were faced by Thailand for the Thai Baht before July of year 1997. The country also has had the weakest fundamentals in economy. After the depreciation of bath the currency of Malaysia, ringgit, currency of Indonesia, rupiah and the currency of Philippines, peso, started facing the same pressure. The three countries have almost the same fundamentals in economy and structure of export as same as Thailand. Since the start of January till the end of October of year 1997, Thailand's baht faced a depreciation by 55 percent as compared to the American Dollar. Rupiah, peso, ringgit, and won of South Korea. It was when in a paper the aforementioned currencies faced a drop by 54, 33, 34 and 14 percent respectively; it was also asserted that the combined devaluation of the currencies held a strong negative effect on other countries in the same region such as Singapore, Taiwan and Hong Kong. By the start of 1998, the gain in American Dollar as compared to the baht was 78 percent, Peso and Ringgit were both 52, Rupiah was 15.1 and Won was 107 percent.. Corsetti et al. (1998).

The variables of macro economy can change the phenomena of economy and also lead to the change of exchange rate on domestic level. Changes in interest rate, whether real or nominal, are the main features of the monetary policy and are also the reason why exchange rates change. Also, at domestic level, the exchange rate can be appreciated if the nominal or real change in interest is positive or vice versa. (Kim and Roubini, 2000).

The value of currency can be increased or decreased with news related to inflation, monetary policy and interest, i.e. macroeconomic variable. The value of currency can be increased with positive change n in the fundamental of the economy while at the same time value of the country's currency can be decreased with a sudden negative change in the same variables. (Ehrmann and Fratzscher, 2005).

The nominal exchange rate holds a negative relationship with interest and inflation rate. While the nominal exchange rate holds a positive relationship with the expectation related to real exchange rate. Hsing (2007).

If the link between exchange and interest rate can be broken by the capital control the currency would not face any devaluation even iv thee interest rate reduces. If interest and exchange rate are linked then the country, with higher liabilities being denominated in the foreign currency, will face depreciation with a decrement in interest rate which will increase the burden of foreign debt. Also the government manages the capita control. It is concluded that the control may be misused by the government to expose the risk by seeking rent and distort then. All of the above are a step towards morals hazards. Krugman (1998).

Statement of the Problem:

To study : The impact of macroeconomic variables on fixed investment in Forex-Exchange market of Pakistan.

Model/Framework to be used:

Variable to be Studied:

The Variable to be studied are as following

Independent variable

Macroeconomic Indicators

Balance of payment

10 year PIB

Interest Rate

Debt

FDI

CPI

PPP

Inflation

KIBOR

Dependent variable

FX-Rate

Proposed Research Hypothesis:

H1: There is significant relationship between 10-year PIB and Pakistan FX-Rate.

H2: There is no significant relationship between 10-year PIB and Pakistan FX-Rate.

H3: There is significant relationship between Balance of Payment and Pakistan FX-Rate.

H4: There is no significant relationship between Balance of Payment and Pakistan FX-Rate.

H5: There is significant relationship between Interest Rate and Pakistan FX-Rate.

H6: There is no significant relationship between Interest Rate and Pakistan FX-Rate.

H7: There is significant relationship between Foreign Direct Investment and Pakistan FX-Rate.

H8: There is no significant relationship between Foreign Direct Investment and Pakistan FX-Rate.

H9: There is significant relationship between Consumer Price Index and Pakistan FX-Rate.

H10: There is no significant relationship between Consumer Price Index and Pakistan FX-Rate.

H11: There is significant relationship between Purchasing Power Parity and Pakistan FX-Rate.

H12: There is no significant relationship between Purchasing Power Parity and Pakistan FX-Rate.

H13: There is significant relationship between KIBOR Rate and Pakistan FX-Rate.

H14: There is no significant relationship between KIBOR Rate and Pakistan FX-Rate.

H15: There is significant relationship between Debt on Pakistan and Pakistan FX-Rate.

H16: There is no significant relationship between Debt on Pakistan and Pakistan FX-Rate.

H17: There is significant relationship between Inflation and Pakistan FX-Rate.

H18: There is no significant relationship between Inflation and Pakistan FX-Rate.

Sources of Information:

The source of Information will be secondary data from State Bank of Pakistan & Bureau of Statistics Pakistan website.

Sampling Technique & Procedure:

Unrestricted non-probability sampling

Convenience based sampling will be used.

Sample Size:

The sample size will be of 1981-2013 data.

Method of Data Collection & Procedure:

Financials will be downloaded from website

Statistical Tests to be used:

MLR

T-Test

Possible Research Findings:

The factors influences the movement in US Dollar as the dependent variable while the Balance of Payment, Foreign Direct Investment (FDI), KIBOR, 10-year PIB, Consumer Price Index(CPI), Purchasing Power Parity (PPP), Debt, Inflation rate and Interest rate as the independent variable. The scope of study in this project paper is around 30 years. Data collected has found from 1981 to 2013. The data will be use to regress it to investigated the relationship of every independent variable toward the factors influenced the movement of Pakistani Rupee.



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