ANALYSIS OF EXCHANGE RATE FLUCTUATIONS: A STUDY OF PKR VS USD

Abstract

The current research is aimed to study the dynamic association between macro economic variables and exchange rate in Pakistan. For this purpose the study analyzes quarterly time series of the relevant variables from 1998 quarter 1 to 2012 quarter 4. The study tests the proposed hypotheses using econometric models that are widely accepted and practiced in academic research in the areas of economics and finance. In the first place the study investigates that whether all-time series variables (exchange rate and the set of seven (7) macro-economic variables) are stationary or not. Then the study investigates in multivariate form, the co-integration properties of the variables under investigation. Further the study applies Granger-cause macro-economic variables or vice versa in the multivariate form. Along this line, the study also applies the Granger-causality test in the bi-variate form to investigate the lead-lag relationship and hence establish the direction of influence i.e. uni-directional. The study results suggest that there is a long-run association between exchange rate and inflation at 10% significance level. The Granger-causality test suggests that the direction of influence is more from inflation to exchange rate than from exchange rate to inflation (though both are statistically insignificant). The results from the Granger-causality test suggest that money supply leads exchange rate i.e. money supply Granger-cause exchange rate (a uni-directional causality). The study reports finding that indicate a bi-directional causality between exchange rate and total reserve less gold. A rise in the total reserve less gold causes exchange rate of Pak Rupee to appreciate and vice versa. The study also reports statistically significant inverse relationship between exchange rate and exports. The findings from the Granger-causality test suggest that exchange rate and industrial production share statistically significant relationship. The study failed to report evidence to support Share price index in multi-variate co-integration test as well as Granger-causality test. The study reported that both balance of trade and exchange rate were co-integrated. Further the study reports that exchange rate Granger-cause balance of trade in the short-run.