DETERMINANTS OF EXCHANGE RATE IN PAKISTAN (1971-2014)

ABSTRACT
This article focused on the main determinants that affect the exchange rate movement in
Pakistan. The study observed some key variables that are responsible for exchange rate
volitality and analyze the importance of each variable. Annual data for the period of 1971
to 2014 is used. Data gathered from websites of State Bank of Pakistan,
tradingeconomics.com, theglobaleconomy.com and IMF data of Pakistan. The key
independent variables of this study includes GDP, interest rate, export, import, foreign
exchange reserve, inflation rate and money supply that directly or indirectly affects
exchange rates of Pakistan. Linear regression with coefficients and correlations applied to
examine the results. The results indicate that GDP and export of Pakistan are the primary
factors affecting the exchange rate of rupee against U.S. dollar. The third most important
factor is inflation higher the rate of inflation lower will be the exchange rate. Foreign
exchange reserve, interest rate, import and money supply are not significantly related to
exchange rate of Pakistani rupee. Based on the results it is recommended that export
activities should be increased in Pakistan and monetary and fiscal polices should be made
more efficient to reduce inflation and strengthen economic growth.
Key words:
Exchange rate volatility, gross domestic product, inflation, export, linear regression,
coefficient, correlation

ACKNOWLEDGMENT
First, I want to thank Almighty Allah for giving me a chance to prove myself. I would like to express
my gratitude towards my parents and my supervisor for their kind co-operation and guidance as well as
for providing me necessary information from time to time regarding the research. Precious support
from my family and friend enable me to complete this research.

Contents
ABSTRACT..................................................................................................................................iii
CERTIFICATE.............................................................................................................................iv
DEDICATED TO...........................................................................................................................v
ACKNOWLEDGMENT..............................................................................................................vi
LIST OF TABLES......................................................................................................................viii
LIST OF FIGURES......................................................................................................................ix
LIST OF ABBREVIATIONS........................................................................................................x
INTRODUCTION.........................................................................................................................1
1.

Background of the Study:.....................................................................................2

21.

Statement of Problem............................................................................................3

31.

Justification...........................................................................................................3

41.

Purpose of the Study.............................................................................................4

1.4.1

General Purpose.............................................................................................4

1.4.2

Specific Purpose............................................................................................4

51.

Basic Assumptions................................................................................................5

61.

Definition of Key Terms.......................................................................................5

71.

Scope.....................................................................................................................5

81.

Limitations............................................................................................................5

91.

Hypotheses............................................................................................................6

LITERATURE REVIEW..............................................................................................................7
RESEARCH METHODOLOGY...............................................................................................15
13.

Design Strategies.................................................................................................16

23.

Population...........................................................................................................17

3.

Sample.................................................................................................................17

43.

Research Tools and Techniques..........................................................................18

53.

Validity................................................................................................................20

63.

Reliability............................................................................................................21

DATA ANALYSIS AND DISCUSSION.....................................................................................22

3

4.1

Anlysis of dependent variable..23

4.1.1 Exchange rate in Pakistan..23

4.2

Analysis of independent variables..................................................24

4.2.1GDP growth rate in Pakistan...24

4.2.2
4.2.3
4.2.4
4.2.5

Inflation rate in Pakistan.............................25

Interest rate in Pakistan...27
Export in Pakistan..28
Import in Pakistan..30

4.2.6Annual growth of money supply in Pakistan.....31

4.2.7

Foreign exchange reserves of Pakistan.32

SUMMARY, FINDINGS, CONCLUSION AND RECOMMENDATIONS...........................39

15.

Summary.............................................................................................................40

25.

Findings...............................................................................................................41

35.

Conclusion..........................................................................................................41

45.

Recommendations...............................................................................................42

References.....................................................................................................................................43
APPENDIX A...............................................................................................................................45
APPENDIX B

LIST OF TABLES
Table 1: Model summary 38
Table 2: ANOVA 38
Table 3: Coefficient of determination 40
Table 4: Correlation 41

LIST OFFIGURES

Figure 1: GDP in rupees per U.S. dollar 6

Figure 2: Pakiatani rupee exchange rate against 1 U.S. dollar.. 27
Figure 3: Pakistan GDP millions of U.S.dollar.. 29
Figure 4: Pakistan inflation rate in percentage................................................................ 30
Figure 5: Pakistan interest rate 32
Figure 6:Pakiatan exports in PKR million. 33
Figure 7:Pakiatan imports in PKR million.. 34
Figure 8: Annual growth in money supply (M2) in percentage 35
Figure 9: Pakiatan foreign exchange reserves in billions of U.S. dollars 36

LIST OF ABBREVIATIONS
SBP State Bank of Pakistan
GDP Gross domestic product
FDI Foreign Direct Investment
FER Foreign Exchange Reserves

CHAPTER-ONE
INTRODUCTION

1.1 Background of the Study:

Every country has its own financial market and it is the base of every nations economy. Financial
markets include foreign exchange markets, interest rate markets, import and export markets etc.
Exchange rate plays an important part in the international trade and finance because it is the most
watched and monitored measure of economy. State Bank of Pakistan (SBP) is the central authority that
is responsible for the issuance of currency all over Pakistan. Before 1971,Pakistani rupeewas connected
with Pound sterling but in 1971, it was linked with US Dollar because of the rapid increase in demand
of Dollar in Pakistan. In 1982, Pakistan was fallen into a budget deficit so Pakistan decided to adopt a
managed floating exchange rate system because this system was helpful in decreasing the gap between
official rates and market rates during this period Pakistani rupee delinked from U.S dollar. During
managed floating exchange rate system, central bank becomes main player because they hold stock of
foreign currency.In 1998, to minimize the financial crisis Pakistan adopted multiple exchange rate
system to solve the problem of trade deficit and to increase the efficiency of Pakistani rupee.The
economy recovered from the crisis in 1999, and it was decided to peg the currency with US dollar
again. In 2000, the State Bank of Pakistan applied a market based exchange rate system.During 2007 to
2008, Pakistani rupee devalued against US Dollar by about 23% due to the increased import activities,
political instability and current account deficit. There is a floating exchange rate system practiced in
Pakistan since then and this system may lead the country to suffer from economic instability and high
risk of crisis if the economy faces high inflation. Pakistani rupee is continuously declining against US
Dollar. In 1982, the exchange rate between the two currencies was Rs.10.39, which increased to Rs.
85.75 in the year 2010. Currently one US Dollar is equal to 101.9 Pakistani rupees, which shows that
the government and central bank is unable to control exchange rates. As the Pakistani rupee is
devaluing so, it is very important to determine those factors that are affecting the exchange rate of
Pakistani rupee.(Salim Chishti, 1993)During 2011-2012 Pakistani, currency was under pressure
because of the decline in the external account of the country and due to large amount of payment of
IMF loans. The main factors or independent variablesof this study are inflation, interest rate, money
supply, import, export, GDP growth rate and foreign exchange reserves, whichdirectly or indirectly
affect the exchange rate (dependent variable) movement in Pakistan.
One of the essential reasons of continuous devaluing of currency in exchange rate is deficit GDP. There
10

exist a positive relationship between GDP growth rate and the level of exchange rate. Growth ratein
early 70s were 4.8%, which expended to 6.5% in 1980s but the growth rate fell to 6.4% in 1990s and
currently the growth rate is 4.14%. When GDP increases the demand for goods and services increases,
which would be beneficial for both importers and exporters.The influence of GDP is high on exchange
rate accompanied by other variables such as inflation rate, interest rate,import and export. Exchange
rate volatility decreases export activities within a country. If for instance an an individual invests into
US Dollars and the exchange rate changes, strikingly between the times you buy and the time you plan
to sale it might be conceivable that the positive return will transform into a negative one.
1.2 Statement of Problem
Exchange rate is the most important component that directly affects the economic growth of a country.
In the current economic condition, it is very important to look into those factors that are directly
responsible for the devaluation of the currency. Determining the factors that positively or negatively
affect the exchange rate is the main research question andissues related to the factors negatively
affecting exchange rate needs to be answered.
1.3 Justification
Thereason behind conducting this research is to find out appropriate purpose of why Pakistani rupee is
continuously depreciating so it is very necessary to take into account those key factors that are affecting
the exchange rate of Pakistan.Because exchange rate is very important for any country as they
determine the level of import and export and directly associated with the economic growth of a country.
If Pakistan has a strong currency so, its goods become more expensive in the international market,
whichwill result in competitive strength.

Figure No.:1

GDP in rupees per U.S. dollar

11

GDP in Rs. per U.S Dollar

120

100

80

60

Rs. per U.S Dollar

40

20

1.4

Purpose of the Study

1.4.1 General Purpose

The purpose of this study is to identify the main determinants of exchange rate in Pakistan and to
analyze the strong impact of all independent variables on dependent variable that is exchange rate.
1.4.2 Specific Purpose

12

To investigate either economic growth affects exchange rate positively or negatively.

To analyze all the important factors and detect which of these factors are significantly affecting the
exchange rate of Pakistani rupee.
To study the influence of interest rate and inflation on the exchange rate of Pakistan.
To take into account the foreign exchange reserve affect on the Pakistani developing economy.
1.5 Basic Assumptions
It is anticipated that exchange rate volatility and all the variables taken into account have a deep and
strong relationship with each other and these variables play a very important role in the international
market.
1.6 Definition of Key Terms
Exchange rate: A rate at which one currency is traded for another.
Multiple exchange rate system: A system where a country will have both fixed and floating foreign
exchange rates at the meam time and both can be utilized when tradinging currencies in that country.
Sterling: Excellent or outstanding
Volatility: Unpredictability
GDP: Total market value of the final goods and services produced within a country during a particular
year.
1.7 Scope
This study is beneficial as it investigates the effect of independent variables on dependent variable that
is exchange rate movement in Pakistan from 1971 to 2014. This research is helpful in recognizing the
main causes of devaluation of currency against U.S Dollar.

13

1.8 Limitations
The study is limited only to the financial sector of KSE 100. There are some basic variables, whichare
considered to be of utmost importance however, there may be many other determinants, which are not
taken into consideration but have strong influence on the study.
1.9 Hypotheses
H0: Inflation is significantly related to exchange rate.
H1: Inflation is not significantly related to exchange rate.
H0: Interest rate is significantly associated with exchange rate.
H1: Interest rate is not significantly associated with exchange rate.
H0: Import activityis significantly related to exchange rate of Pakistan.
H1: Import activity not significantly related to exchange rate of Pakistan.

14

CHAPTER-TWO
LITERATURE REVIEW

15

This section discussed scholarly theoretical and empirical literatures, which are important in
consideration to the research topic as it will be helpful in understanding the inputs, which have been
used, and to determine the gap that needed to be closed through this study. Another important purpose
of writing literature review is to have necessary knowledge regarding the topic under study. These
articles will behelpful in conducting further research.The articles reviewed used many different
variables and various test were conducted to find an appropriate conclusion in every research. Every
study has some link with the previous study. The test used was regression, unit-root test, co-integration,
correlation and error correction strategy. The time period of every study vary greatly. The articles taken
into account belong to different economies but the dependent variable of every article was same that is
exchange rate except the study of Atiq-ur-Rehman where exchange rate is used as an independent
variable. Some authors like Yan Li and Zakaria have compared the exchange rate of many countries
together. All studies were secondary in nature and used many different sources to obtain data.
Razi used in his study several variables out of which many of the independent variables are positively
as well as negatively related to exchange rate movement. Farrukh in addition just focused on real
exchange rate as an important component of economic growth. Shabana in her study has mainly
considered two key variables that have strong impact on exchange rate of Pakistan but the duration of
her research vary greatly as compared to previous articles reviewed. Saeed made efforts to find out the
determinants affecting exchange rates but only in long run. Zahoorlooked on other variables such as
reserve money and manufacturing products responsible for exchange rate predictability. Iqbal in
connection with the above mentioned reviews have focused mainly on macro economic variables.
Muhammad conducted the same research as Razi but used unconventional approach.Salim made
further modifications by stating that there is a negative relationship between vitality of exchange rate
and foreign trade. Lious and Anita have also studied macro economic variables but of Nigerian and
Indian economies. Imran and Hassan have discussed inflation in detail in accordance with the
unpredictable exchange rates. Taylor discussed relationship of foreign exchange markets and exchange
rate volatility by keeping in view key macro economic variables.

Raziet. Al.in their study presented exchange rate volatility and recommended that exchange rate has

16

greater impact on profitability of businesses if they have foreign direct investment. Main determinants
used in their study include interest rate, inflation, current account deficit and public debt. This article
further discussed how independent variables affect the exchange rate and what changes take place in
overall economy of Pakistan. Data collected by using secondary sources. Data collected for the period
of 2001 to 2011 with 10 numbers of total observations. The research used multiple regression equation
in order to analyze the relationship between exchange rate represented by Y ( dependent variable) and
the interest rate, inflation rate, current account and GDP represented by X ( independent variable). The
result of this researchsummarize as independent variables deeply related with dependent variable. It
showed that exchange rate change with the changes in economic factors. Analysis showed that
independent variables have positive and negative relation with exchange rate and havingstrong
correlation coefficient and coefficient of determination.Therefore, this model wasoverall significant.
(Amir Razi, 2012)
Based on the first literature review this article is consideredbecause it includes more variables that
cause exchange rate volatility. Furrukh Bashir et. Al. analyzed that real exchange rate is an important
component in the growth of the economy as it may increase export and decrease import activities in the
country. As first study only focused regression, so in addition this study used co-integration, error
correction model, unit root test and VAR lag order. This study aimed to examine the determinants of
exchange rate in Pakistan. Data was collected from 1972 1973 to 2012 2013. The study concluded
that real exchange rate depreciates against trade deficit and Price level. Trade restrictions and workers
remittances inversely related to exchange rate of Pakistan.(Luqman, 2014)
This literature has covered a broad period starting from 1975-2010 but study focused on inflation and
growth rate only. ShabanaParveenet. Al. studiedthat equilibrium in exchange rate is determined when
demand and supply of foreign currency vary. As the demand increase or decrease for any currency, it
obtains the clearing price for that currency.The stationarity of data was determined, by using
Augmented Dickey-Fuller test. Akaike Information Criterion and a linear regression model were also
used. Stationary of the Variables were checked first by using intercept and then an intercept and a linear
deterministic trend was included. The study concluded that inflation and growth rate have a negative
relation with exchange rate. (Shabana parveen, 2012)

17

Ahmed Saeedet. Al.obtained data from January 1982 to April 2010 to examine the behavior of
Pakistani rupee with respect to USA exchange rate by applying error correction mechanism and
autoregressive distributive lag approach to estimate the long run relationship between exchange rate
and explanatory variables.Exchange rate has strong effect on price, wages, interest rate, production
level, and employment opportunity. One way to determine exchange rate is that the demand for and
supply of currencies with flow concept determines the equilibrium value of currencies. The other is the
equilibrium value of financial assets determines the behavior of exchange rate. It was concluded that
money stock, foreign exchange reserves and debt PKR/USD in relative terms are critical determinants
of exchange rate between Pakistani rupee and U.S dollar. According to this study fiscal and monetary
policy in addition with political stability were required to maintain the exchange rate stability in
Pakistan. (Ahmed Saeed, 2012)
Atiq-ur-Rehmanet. Al. considered exchange rate here as a variable that directly controls the balance of
trade in a country. The variables he used in his study were exchange rate, export and import. Data
obtained from World Development Indicators (WDI) 2010 database. JS curve theory was used to find
out appropriate results. Results of Pak currency depreciation increase debt burden so it was
recommended to apply such policies that stabilize exchange rate movement to avoid debt burden.(Atiq
UR rehman, 2012)
ZahoorHussainJavedet. Al.collected data from 1982 to 2007 and investigated the relationship between
economic growth and exchange rate unpredictability in Pakistan. Economy growth, exchange rate,
imports, exports, manufacturing products (MP) and reserve money are the main variables used in the
study. This study has focused on the economic problem faced bydeveloping countries due to
unpredictable exchange rates. Error collection mechanism and autoregressive lag model were used and
it was found that an empirical relationship exist between economic growth and exchange rate
unpredictability. Co-integration relationship between all variabeswas found in long run except import
and export.The result was that the domestic economic performance was exceptionally touchy to
uncertain exchange rate in the long -run period.(Zahoor Hussain Javed, 2009)
IqbalMahmoodet. Al.stated that exchange rate directly affects the macroeconomic variables of the
country and it further discussed that whether changes in exchange rate influence the macro economic

18

variables in Pakistan. Data was collected from 1975 to 2005 with a series of 31 observations. This
study was conducted in order to determine whether the uncertainty of exchange rate affect the
macroeconomic variables or not. Autoregressive model was used to determine the stationary levels of
all variables. GDP, FDI, trade openness and growth rates were the independent variables which directly
affects the dependent variable that is exchange rate. The result of this paper shed light on the fact that
exchange rate has a great impact on macroeconomic variables in Pakistan and exchange rate volatility
has positive effects on GDP, growth rate and trade openness but has an adverse relationship with FDI.
(Iqbal Mahmood, 2011)
Mohammad Ahmed conducted his study on determinants of the exchange rate in Pakistan since 1982
by using unconventional approach. It investigated the important factors, which encourage the SBP to
announce changes in the rupee. Error correction model and auto regression technique were used. In
integration and co-integration,vector auto regression techniques have been used. Concluding that in the
short run one must do discretionary management of Pakistani rupee with the movement of dollar and in
long run relative inflation should be redeemed. Under suitable condition, the burden of adjustment and
recession may occur in Pakistani export sector.(Ahmed, 1992)
Yan Li et. Al. conducted study to determine reappraisal of exchange rate both in tradable and nontradable products. The qualitative and quantitative implications were evaluated under adaptable costs.
Data collected from 1985 to 2005 for six countries namely Canada, Denmark, Japan, Sweden, United
Kingdom and United States with 20 total number of observations. The panel dynamic OLS regression
was applied to liquidity-exchange rate model. Government, household and goods market are used as
independent variables. The findings concluded that co-integration relationship exist between
macroeconomic factors and nominal exchange rates which was analyzed by consolidating a symmetric
two nation model with the restricted support of tradable and non-tradable merchandise.(Yan Li, 2010)
SalimChishti and M.A YnulHasan stated this paper to take into account relevant variables that affect
exchange rate. Co integration and error correction technique was used along with VAR model. The
variables used were real exchange rate, nominal exchange rate, wholesale price index for US, consumer
price index for Pakistan, excess supply of domestic credit, real gross domestic product, ratio of
government deficit, terms of trade, tariff revenues and capital inflows. The overallresponse of the

19

exchange rate to changes in variables are consistent with theoretical predictions. The result is that the
variety of these real and monetary influences indicates flexible discretionary managed policy.(Salim
Chishti, 1993)
LouisKuijspresents a macroeconomic condition of Nigerian economy by using data from 1983 to 1997.
The paper discussed estimated long run relationship of markets of money, foreign exchange and output.
Dynamic equations were used for price level, real exchange rate and output. The three important
variables used were inflation, exchange rate and output. The results were instrumental in explaining the
role of the foreign exchange market and depreciation of exchange rate since 1985 and the effect of
inflation during 1991-97.(Kuijs, 1998)
Muhammad Zakariaet. Al. examines the role of variables that determines nominal exchange rates in
Pakistan. Quarterly data collected for the period of 1983 to 2004 for 12 major countries namely
Australia, France, Germany, Italy, Japan, Kuwait, Korea, Malaysia, Singapore, Switzerland, the United
Kingdom and the United States. Generalized Methods of Moments (GMM) estimation was used. The
correlations coefficients were highly positively correlated. The result showed that nominal exchange
rates depend on a number of variables both in local and foreign economy. Specially policy-induced
shocks were shown to be the cause of instability in nominal exchange rates.(Muhammad Zakaria, 2007)
Imran Sharif Chaudhryet. Al. studied empirical relationships between foreign exchange reserves and
inflation in Pakistan for the period of 1960 to 2007 with 48 total observations. This study analyzed the
impact of foreign exchange reserves on inflation rate in Pakistan. The Auto Regressive Distributive Lag
Model was used to estimate the order of co-integration between inflation and foreign exchange
reserves. The result indicated that any short fall in foreign exchange reserves in Pakistan undoubtedly
has some adverse effects on cost of goods and services, but it may not be as strong as predicted.(Imran
Sharif Chaudhry, 2011)
Hassan Al-Hajhojet. Al. investigated the determinants or the real exchange rate of the Gulf Cooperation
Council (GCC) countries as a prerequisite. Standard Augmented Dickey-Fuller (ADF) unit root test and
Eagle Granger two step co-integration technique were applied to determine the appropriateness of
model using the VEC for each GCC country. The study results indicated that the estimated error
correction coefficients were not significant for all the GCC countries. The study highlighted
20

determinants of RER that are helpful to establish monetary union in the GCC countries.(Hassan Al.
Hajhoj, 2014)
RudigerDornbusch (1976) discussed the study of exchange rate movements. The purpose was to
develop a theory that is suggestive that such exchange rate movements are consistent with rational
expectations formation. Data of a small country that faced inflation is discussed here. Variables used
were capital mobility, money market, goods market and equilibrium exchange rates were used. The
magnitude and persistence of overshooting were used. The result suggested that the fixed output
adjustment was suitable in short run. In the intermediate run, the present analysis gains relevance,
because it would expect an adjustment of both output and prices in response to increased demand.
(Dornbusch, 1976)
Marialuz and Alex focuses on the case of Brazil. Data collected for the period 1983 to 2011 using a
sample of 28 emerging markets it estimated a dynamic model of the real exchange rate. The five
determinants used were namely Relative GDP per capita (GDPPC), Balance of goods and services
(TB), Structural balance (SB), Relative public consumption (PC) and Relative public investment (PI).
Result suggested that a permanent fiscal adjustment may reduce countrys appreciation pressure over
the long term, maintaining fiscal policy by increasing public investment in Brazil this will help to
reduce appreciation pressures and help dealing with budget deficit.(Marialuz Morene Badia, 2014)
Anita Mirchandanidescribed macroeconomic variables and their relationships with exchange rate. Data
collected for the period of 1991 to 2010 of Indian economy. The variables used were interest rate,
Balance of trade, Inflation rate, Foreign Direct Investment, GDP etc which were directly related to
exchange rate volatility. It is concluded that Indian Rupee has shown high volatility in few years
because of the independent variables. Rupee depreciation was one outcome. In present condition
without having stable source of capital inflow, the Rupee is expected to remain significantly volatile.
(Mirchandani, 2013)
Abdul Rashid and Mashael investigated the effects of 2008 financial crisis on exchange rate
determination in PPP-UIP. Data collected for the period 1981 to 2012. Augmented Dickey-Fuller unit
root test and panel unit root test, namely Fisher-type tests were applied. The results suggested that the
recent financial crisis changed the role of exchange rate determinants. The results were different in all
21

the economies. The findings were best for policy makers in designing effective policies to reduce the
affects of financial crisis on exchange rates.(Abdul Rashid, 2013)
Mark P. Taylordiscussed relationship of foreign exchange market and the exchange rate volatility.
Selective survey was done to obtain data to further carryon research. This article used flexible price
monetary model, sticky price and overshooting monetary model to determine exchange rate movement
in long-run as well as in short-run. Equilibrium and liquidity models, portfolio balance method and
empirical evidence on exchange rate models were also used. The result suggested that in short-run
exchange rate movements were based primarily on macroeconomic fundamentals was not proved to be
successful. (Taylor, 1995)

CHAPTER-THREE
RESEARCH METHODOLOGY

22

Research design is a composed approach to fulfill exploration prepare in a way wanted to settle the
examination issues and to expand bits of knowledge.(Babbie, 2002) Research design is the foundation
that depicts the methods for gathering and examining information. (Mc Millan, 2001)
3.1Design Strategies
The type of study conducted is causal in nature.Causal study is an examination study directed to build
cause and influence connections between variables. (Uma Sekaran, 2012) The study is causal in nature
as it explores the effect of key independent variables on the dependent variable that is exchange rate.
The causal study is helpful to show a direct relationship between variables. The key independent
variables of this study are inflation rate, GDP growth rate, interest rate, export, import, annual growth
in money supply and foreign exchange reserve. All these variables are having a direct relationship with
exchange rate.
The type of research with respect to the data is quantitative. Quantitative information utilization test
procedures whose discoveries are communicated numerically or scientifically that help the analyst to
assess future amounts.(Mark Saunders, 2007) Quantitative data used in order to calculate regression,
correlation and co-integration. Quantitative data is more appropriate than qualitative data as it tries to
assess the issue and perceive how universal it is by searching for predictable result in a larger
population.
To examine the behavior of Pakistani rupee against U.S. dollar annual time series data used because
this study is dealing with different measures of unpredictable exchange rate. A time series data consists
of periodic arrangement of observations on one or more variables overtime. (Asteriou, 2006)The data
of many years taken into account so that it may become easy to notice the reasons of continuous
devaluing of Pakistani rupee for this purpose yearly data of forty-four years is considered. Time series
is important for understanding past behavior of the variables that are directly or indirectly affecting
dependent variable. Time series data denoted by symbol t if for example X represent exchange rate
of a country from 1971 to 2014 so it is represented as:
Xt for t =1,2,3,4,,T
Where t=1 for 1971and t=T=44 for 2014
23

This study used secondary sources to gather data for research. Secondary data is the data, which the
researcher did not collect directly from respondents or subjects. Some other researcher or institutions
whose job is to gather data may collect it. (Greener, 2008)Second hand information that is assembled in
this study by inspecting different documents from different public sources listed as follows:

Journals

Articles

Books

Magazines

Data gathered from websites of State Bank of Pakistansbp.org.pk, IMF data of

Pakistan,tradingeconomics.com, theglobaleconomy.com and world economic outlook as these
resources have the most appropriate data needed to carryon this study. Secondary sources to assemble
information used here because the data is readily available, very economical, can be observed over
longer period and it is inexpensive to obtain data from internet by searching different reliable websites.
3.2 Population
The destined population for this on hand study used annual data of sixty-seven years that is from 1947
to 2014 so that the study may be able to explore the reasons of continuous currency depreciation
against U.S dollar.
3.3 Sample
For this research study, the effects of determinants on exchange rate of Pakistani rupee against U.S
dollar over the period of forty-four years (1971-2014) with 44 total observations are considered. Out of
sixty-seven (67) total number of population a sample of forty-four(44) numbers of total observations
are taken in this study so that it can point out the main causes of devaluation of Pakistani rupee. These
large numbers of observation will be helpful to easily find out key variables that are affecting exchange
rate of Pakistan over a period of time.

24

3.4 Research Tools and Techniques

In order to carryon, this research many tools such as MS word, internet,googledoaj, SPSS software to
run regression and correlationwere used to view different literatures and collection of data for
analysis.Excel sheet was also used to make graphs related to the study.
Regression and correlation as the statistical tools or techniques used in this research because regression
is helpful in measuring the relationship and strength between value of one variable and corresponding
value of other variables.On the other hand, correlation is beneficial in establishing a connection
between two or more variables.
Excel sheet is used to make graphs with exponential trend line to explain the movements of key
independent variables against dependent variable.The trend line might be declining for some variables
and increasing in case of other variables depending on the tendency of exchange rate volatility. In order
to analyze the variables that are directly affecting the exchange rate of Pakistan a regression model is
used. The following is the main regression equation, whichis used to carry on further analysis:
Y= + 1GDP + 2INF + 3I + 4X + 5IMP + 6F.E.R + 7M.S +
Where,
Y = exchange rate (dependent variable)
GDP = gross domestic product
INF = inflation
I = interest rate
X = export
IMP = import
F.E.R = foreign exchange reserve
M.S = money supply
25

 = residual term

Inflation

Growth
rate

Export

Import

Exchange rate

Interest
rate

Price
Level

Money
supply

Theoretical Framework

3.5 Validity
Validity is a measure that the instrument, technique or process used to measure a concept does certainly
26

measure the planned concept. (Uma Sekaran, 2012)Validity implies whether the findings are truly
about what they seems to be, to verify that examination result are effective and helpful, approval of the
amazing significance. (Robson, 2002)
In case of this study, the aim is to analyze the sensitivity of determinants to the unpredictable exchange
rate movements. Validity must be tested first to make sure that the variables measure what they aimed
to measure. Changes in exchange rate represent the exchange rate movement. There is a causal
relationship between all key independent variables and exchange rate. This research will satisfy validity
because the methods used here are scientific and reasonable. 90% confidence level is estimated which
means that there may be 10% chances of error.The confidence level is otherwise called level of
significance.
3.6 Reliability
Reliability shows the extent to which it is error free and guarantees consistent estimation across time
and various things in the instrument. (Uma Sekaran, 2012)Reliability refers to the extent to which data
collection techniques or analysis technique will yield unchanged findings. (Robson, 2002)
Consistency refers to the term reliability. The data obtained from various sources is trustworthy. It is
assumed that the result obtained is consistent with the prior studies. The data collection techniques and
analysis procedure is free from any type of error and biasness.

27

CHAPTER-FOUR
DATA ANALYSIS AND DISCUSSION

28

Many variables have a direct or indirect affect on the exchange rate of Pakistani rupee against U.S.
dollar. The variables used in the analysis include exchange rate, GDP growth rate, export, import,
annual growth in money supply, inflation, interest rate andforeign exchange reserve.
4.1 Analysis of dependent variable:
4.1.1 Exchange Rate in Pakistan:
All the countries in the world have many different currencies, with distinct values so when trade takes
place between countries for this purpose exchange system was invented. Exchange rate is a rate at
which one currency is exchange for another. It is the dependent variable of this study. State Bank of
Pakistan is continuously trying to manage the exchange rate of Pakistani rupee against U.S. dollar but
still the currency is subject to unpredictable capital outflows. Since the existence of Pakistan on the
map of world there are different exchange rate policies practiced in Pakistan. These policies include
flexible floating, managed floating and fixed exchange rate. This study is mainly conducted to look into
those factors that are responsible for the devaluation of Pakistani rupee against U.S. dollar. Exchange
rate remains stable during the year 1973 to 1981. The depreciation of currency may be caused by
demand and supply factors. Some times little devaluation of currency could be beneficial for the
country as it increases exports on the other hand, it increases liability and foreign loan payments.The
factors considered are directly or indirectly related to exchange rate. These factors creates hurdles in
exchange rate stability. The graph shows variation in exchange rate these variations increases during
greatly during the period of 1971 to 2014. The exchange rate was at a height of Rs.104 in 2014 and
recorded lowest at Rs.8.6 in the year 1972.

29

Figure No. 2:

Pakistani rupee exchange rate against U.S. dollar

Pakistani rupee rate against 1 U.S. Dollar

$120.00

$100.00
Pakis tani rupee rate agains t 1 U.S. Dollar
$80.00

$60.00

$40.00
Exponential (Pakis tani rupee rate agains t 1 U.S . Dollar)
$20.00

$-

4.2 Analysis of independent variables:

4.2.1 GDP Growth Rate in Pakistan:
GDP is the total market value of all the final goods and services produced within a country during a
particular period. Pakistan is a developing country and its economy is the 27th largest economy of the
world in term of purchases.The main reasons in decline of GDP includes illiteracy,corruption,
30

unemployment, lack of foreign investment, low level of productivity, political instability and law and
order situation in the country. With the increasing GDP, the demand for goods will also increase as it is
estimated that GDP is positively related to exchange rate volatility. If the growth rate is high it would
be beneficial for both the importers and exporters because they can enjoy maximum benefits with the
increased growth rate.
Pakistan is one of the least developed countries in Asia. It has a semi-industrialized economy that relies
mostly on agriculture, manufacturing and remittances. Pakistani economy incorporates multiple
essential elements such as traditional farming in village areas as well as modern agriculture, advance
commercial enterprises, handicrafts and a huge number of administrative services. Services or simply
the trade sector are the real source of financial development representing a large portion of Pakistans
aggregate national income with around 33% workers employed in this division. The development in
industrial sector specifies that it has shown a substantial growth in contrast with other two sectors with
the passage of time.The gross domestic product (GDP) in Pakistan expended 4.14 percent in 2014. The
GDP growth rate in Pakistan averaged 4.92 percent from 1952 to 2014, reaching on a height of 10.22 %
in the year 1954 and the lowest record was of -1.8% in 1952. Although since 2005 has been growing at
an average 5% per year but it is not enough to keep up with the fast growing population. The Pakistan
Bureau of Statistics reports GDP growth rate in Pakistan.
Figure No. 3:

Pakistan GDP rate in current U.S. dollar

31

Pakistan GDP (Billions of U.S. dollars)

300

250

200

150

Pakistan GDP (Billions of U.S. dollars)

Exponential (Pakistan GDP (Billions of U.S. dollars))

100

50

[Source: www.tradingeconomics.com]

4.2.2 Inflation Rate in Pakistan:

Inflation rate is the percentage rate of change of price index overtime. Inflation is the state in which the
value of money is falling and the prices are rising. (Crowther, 2011) Inflation leads to uncertainty about
the future purchasing power of money, which ultimately results in decreased savings and investments.
This also increases imports while discouraging exports that lead to trade deficit in a country. In
Pakistan, inflation is mainly caused by declining economic growth, high tax rates and continuous
depreciation in the value of rupee. Due to inflation purchasing power decreases, it is not good for
retired and poor people as they receive a fixed amount of money so the spending power remains
decreasing each month because these people hold less number of tangible assets and equities and
32

mostly keep their investment in the form of cash or deposits, which ultimately looses value during
inflation. Store of value is the function of money, which is also,weakens through adverse affect of
inflation in Pakistan. Inflation is of utmost importance to the policy makers.
The countries having a higher inflation rate usually faces devaluation of their currency in connection
with the currencies of their tradind partners. Inflation usually accompanied by higher interest rates.The
figure illustrates the exponential trend of inflation in Pakistan. In late 1970s and 1990s, there was a
double-digit inflation in Pakistan. Late 1970s was the most unstable period of inflationary uncertainty
for Pakistan. The inflation rate in Pakistan reach on a height of 37.14 % during the period 1973 to
1975 and the lowest record was in 2001 to 2002 of just 3%. The period of 1973 to 1975 is the supposed
to be the worst episode in the inflationary history of Pakistan and the main cause of high inflation
during this period was hike in oil prices and poor agricultural production. A firm monetary policy along
with fiscal integration contributed a lot in low inflation during 2000 to 2003 as this period has a broad
money growth in agriculture, industrial and trading or servicing sectors.
Figure No. 4: Pakistan inflation rate in percentage

33

Pakistan Inflation rate in %

40.00%
35.00%
30.00%
25.00%
20.00%

Pakis tan Inflation rate in %

Exponential (Pakis tan Inflation rate in %)

15.00%
10.00%
5.00%
0.00%

[Source: www.tradingeconomics.com]
4.2.3 Interest Rate in Pakistan:
Interest rates are the rent paid by a borrower (debtor) to a lender (creditor) for the use of moneyover
time, and they are express in percentage terms per annum. (Faure, 2011). This study focused on lending
interest rate of Pakistan.Interest rate is one of the most important factors that affect the exchange rate
movement. Interest rate is helpful for the State Bank of Pakistan to reach its inflation target. Inflation
and interest rates are inversely propotional to eachother. When the interest rate is high, it leads to low
inflationand vice versa. Currencies that have a high interest rate draw attention of many investors to
seek the top most opportunities for their investment. This is helpful in increasing the demand of
currency. Lower interest rate leads to decrease in exchange rate. In Pakistan, the State Bank of Pakistan
takes interest rate decisions. The official interest rate is the discount rate or the market repurchase rate.
(Mirchandani, 2013) Interest rate in Pakistan averaged 12.45 percent from 1972 to 2014reaching at the
height of 20% in 1996 and recorded lowest at 7.5% in 2002. It was stable during 2002 to 2004.
34

Figure No. 5: Pakistan lending interest rates in percentage

pakistan Lending Interest Rates in %

35%

30%

25%

pakistan Lending Interest Rates in %

20%

15%

10%

Exponential (pakistan Lending Interest Rates in %)

5%

0%

[Source: www.tradingeconomics.com]
4.2.4 Export in Pakistan:
The products or goods manufacturednationally and traded internationally are known as export. Export
encourages people to exchange things worldwide firstly this was done by using barter system.But after
the invention of currencies it takes place through exchange rate.Like GDP, inflation and interest rate
export is also an important determinant of exchange rate because increase in export activities result in
higher exchange rate but currency with low exchange rate results in lower exports. It means there is a
positive relationship between export and the exchange rate because when the export activity increases
in a country its exchange rate becomes more stable. Due to advance technology, many of large firms
have winded their business and went abroad only a few popular branded companies are left here.So, the
export base of Pakistan is not as strong as before but government of Pakistan is consistently making
35

efforts to increase export activity. Export is helpful in increasing revenue of a country. It is useful in
balancing growth and is advantageous in gaining new knowledge and experience. On the other hand,
export may include unbearable costs and the exporters may face rejection of products due to
unfavorable political risk.
Pakistans major exports includesraw cotton, lather and products made up of leather, carpets rugs and
tents, synthetic textiles, surgical instruments, sports goods, readymade garments, engineering products,
chemical and pharmaceutical products, vegetables fruits and fish, mineral feuls, manufactured goods,
beverages and tobacco. Pakistani mangoes are the most delighted items that traded in massive amounts
to numerous countries abroad. United States, China, U.A.E and Saudi Arabia are the primary export
partners of Pakistan. The large part of export earnings originates from textile sector. Water scarcity
particularly for agri-use and power shortage especially in Southern Punjab is another drawback of
Pakistani export. Pakistan has a higher export rate with United States that is 13.6%. Export in Pakistan
averaged 34120.04 million PKR from 1972 to 2014 reaching at the height of 275433 million PKR in
2013 and recorded minimal at 830.4 million PKR in 1976. The figure shows a continuous increase in
export, which is good for Pakistan because the value of Pakistani currency also increases with the
increase in export.

36

Figure No. 6:Pakistan exportsin PKR million

Pakistan Exports in PKR million

350000
300000
250000
200000
Pakis tan Exports in PKR million

Exponential (Pakis tan Exports in PKR million)

150000
100000
50000
0

[Source: www.tradingeconomics.com]
4.2.5Import in Pakistan:
When the goodsnot produced nationally or produce in very less quantity so the goods bought from
abroad, it is termed as imported goods. Many countries have to import goods because they either
cannot produce it locally or cannot create enough of it to meet its demand. Import is helpfulas it reduce
reliance on the domestic markets and helps in creating competitiveness among rival firms in local

37

market. On the other hand, imported items increases the risk of getting dangerous deseases like aids
etcfrom the exporting country, it could increase the possibility of excessive competition, and the
imported goods may be defective to some extent.The government of Pakistan controls imports
activities in Pakistan. The main imports of Pakistan are mineral fuels, animal and vegetable oils, crude
materials, chemicals and machinery. The importer must have to make payment in the currency of the
exporting country.China, United Arab Emirates, Saudi Arabia, United States and Kuwait are the
primary import partners of Pakistan. Import in Pakistan averaged 57741.29 PKR million from the year
1971 to 2014 reaching at a height of 472228 PKR million in 2014 and was recorded lowest of 228 PKR
in 1971.
Figure No. 7: Pakistan imports in PKR million

38

Pakistan Import in PKR million

500000
450000
400000
350000
300000
250000

Pakis tan Import in PKR million

Exponential (Pakis tan Import in PKR million)

200000
150000
100000
50000
0

[Source: www.tradingeconomics.com]
4.2.6 Annual Growth of Money Supply in Pakistan:
Money supply is definedas the aggregate sum of money that is currently circulated in a
country.Circulation of money is being controlled by the central banks.Monetory policy controls money
supply in an economy through change in interest rate and after every three months State Bank
announces a new monetary policy. It is necessary to control money supply because its increase will
cause inflation. Purchase leads to increase in money supply and sales leads to decrease in money
supply. There are some measures of money supply includes M0, M1, M2, M3 and M4. M0 includes
coins and notes in circulation that are easily convertible into cash. M1 includes most liquid assets such
as currency, travelers check, demand deposits and other checkable deposits. M2 adds to M1 other
assets that are not so liquid and includes small domination time deposits, saving deposits, money
market deposit accounts, and money market mutual funds. M2 is considered asthe more advance form

39

of money. M3 in addition to M2 also includes long-term mutual funds. M4 also includes gold and land
and are highly less liquid assets. This study focused on M2 as it has greater impact on exchange rate.
Money supply has shown a substantial amount of decline during several periods. Money supply in
Pakistan reached at a height 29.3% in the year 1993 and recorded lowest in the year 1975 1.2% (in
negative).
Figure No. 8: Annual growth in money supply (M2) in percentage

Annual growth in money supply (M2) in %

35
30

Annual growth in money s upply (M2) in %

25
20
Exponential (Annual growth in money s upply (M2) in %)
15
10
5

Linear (Annual growth in money s upply (M2) in %)

0
-5

[Source: www.theglobaleconomy.com]
4.2.7 Foreign Exchange Reserves of Pakistan:
Foreign exchange reserve is the financial assets held by the State bank of Pakistan that have various
currencies, which are used to pay back its credits over time. The primary center of this study is on U.S.
dollar. Foreign exchange reserve was a single digittill the year 2000 but as the debt burden increases the
State Bank of Pakistan has to increase the holding of its economic resources. Foreign exchange reserve
of Pakistan reached at a height of 17.70 in the year 2013 and recorded lowest in the year 1971.
40

Figure No. 9: Foreign exchange reserves in billions of U.S. dollars

Foreign exchange reserves in billions of U.S. dollar

20
18
16
14

Foreign exchange res erves in billions of U.S . dollar

12
10
8
6

Exponential (Foreign exchange res erves in billions of U.S . dollar)

4
2
0

[Source: www.theglobaleconomy.com]
After explaining and analyzing all the variables and keeping in view the data and graphs of all the key
variables regressionwas run to see how strongly variables are related to each other the following are the
result of regression analysis.

41

Table No. 1: Model Summary

Model

R Square
.971a

Adjusted R Square
.943

Std. Error of the Estimate

.932

7.55653

a. Predictors: (Constant), export rate in Pakistan, inflation rate of Pakistan in percentage, Annual growth in
money supply (M2) in %, interest rate of Pakistan in percentage, foreign exchange reserve, Gross Domestic
Product per capita per U.S. Dollars, import rate in Pakistan

Table No. 2: ANOVAb

Model
1

Sum of Squares
Regression
Residual
Total

Df

Mean Square

34128.348

4875.478

2055.640

36

57.101

36183.987

43

Sig.

85.383

.000a

a. Predictors: (Constant), export rate in Pakistan, inflation rate of Pakistan in percentage, Annual
growth in money supply (M2) in %, interest rate of Pakistan in percentage, foreign exchange
reserve, Gross Domestic Product per capita per U.S. Dollars, import rate in Pakistan
b. Dependent Variable: exchange rate of Pakistan

42

Table No. 3: Coefficientsa

Standardized
Unstandardized Coefficients
Model
1

B
(Constant)

Std. Error

18.462

6.704

.083

.018

export rate in Pakistan

.000

import rate in Pakistan

inflation rate of Pakistan in

Coefficients
Beta

Sig.

2.754

.009

.942

4.517

.000

.000

.607

2.363

.024

.000

.000

-.619

-2.512

.017

.119

.216

.026

.552

.584

foreign exchange reserve

-.355

.709

-.065

-.501

.619

interest rate of Pakistan in

-1.334

.381

-.193

-3.503

.001

-.303

.191

-.064

-1.582

.122

Gross Domestic Product

per capita per U.S. Dollars

percentage

percentage
Annual growth in money
supply (M2) in %
a. Dependent Variable: exchange rate of Pakistan

43

Table no. 4 : correlation

All the above done analysis interprets that the exchange rate of Pakistani rupee against U.S. dollar is
44

consistently devaluing because of all the independent variables but some variables are strongly related
to exchange rate either positively or negatively. The result of regression focus on the fact that despite of
all the variables GDP, export and inflation are the main causes of devaluation of currency.With the
increase in GDP economic growth the exchange rate become stable because larger expected GDP
growth will tend to appreciate the exchange rate. Foreign exchange reserve also reduces the value of
currency but not as efficiently as GDP, export and inflation does.
The correlation coefficient R is 0.971that shows that independent variables and dependent variable
has a strong linear relationship. The coefficient of determination R2 is 94.3%, which shows the
strength of linear association between all the independent variables used and exchange rate. The R2=
0.943 means that 94.3% of the total fluctuation in exchange rate can be described by the linear
relationship between dependent and independent variables. The remaining 5.7% of the total
fluctuations in exchange rate remains unexplained. These 5.7% of the variations in exchange rate may
be cause by some other factors that are not considered in this study.
ANOVA produces a p value of .000 that all the variables are significantly related. The regression
equation describes further changes.
Y= + 1GDP + 2 INF + 3 I + 4 X + 5 IMP + 6F.E.R + 7 M.S +
Y= 18.462+ 0.083 + 0.119 + (-1.334) + .000 + .000 + (-0.355) + (-0.303)
This equation shows that F.E.R, M.S and interest rate have coefficient with a negative sign which
means that increase in these factors can lead to decrease in exchange rate.
The correlation results highlights that GDP and export are strongly correlated to each other while other
variables have a less or moderate correlation. The variables having positive values indicate that
increase in one variable corresponds to increase in other variable but the negative values of money
supply, inflation and interest rates shows that decrease in these variables causes an increase in exchange
rate.
The first hypotheses isinflation is not significantly related to exchange rate which is proved to befalse
as there exist a strong relationship between inflation and exchange rates of Pakistani rupee against U.S.
45

dollar. R2 is 0.813, which is greater than zero so relationship exist between the variables but this
relationship is very strong.
R2= 0.813> 0 and R=0.901 >0,
So here H10, which means that there exist a strong relationship between interest rate and exchange
rate. This hypotheses proved to be false.
The second hypotheses are interest rate is not significantly associated with exchange rate.This
hypotheses also proved to be falseas there is a moderate relationship found between interest rate and
exchange rate because the coefficient of determination and correlation is greater than zero. R2 is 0.288,
which is greater than zero so relationship exist between the variables but this relationship is moderate.
R2= 0.228 > 0 and R=0.536 >0
So here H10, which means that there exist a relationship between interest rate and exchange rate. This
hypotheses proved to be false.
The third hypotheses isimport activity not significantly related to exchange rate of Pakistan. The result
shows that there is a relationship between import and exchange rate. This hypotheses also proved to be
false as their exist their exist a relationship between inflation and exchange rate because the coefficient
of determination and correlation is greater than zero. R2 is 0.01 which is greater than zero so a
relationship exist between the factors but this relationship is not very strong.
R2= 0.01 > 0 and R=0.099>0
So here H10, which means that there exist a relationship between import rate and exchange rate. This
hypotheses proved to be false.

46

CHAPTER-FIVE
SUMMARY, FINDINGS, CONCLUSION AND RECOMMENDATIONS

47

5.1 Summary
This research paper aims to find out the main determinants that directly or indirectly cause the
exchange rate volatility. Data of forty-four yearsis observed to determine the main reasons of
continuous devaluation of Pakistani currency. All the variables used here are positively or negatively
related to unpredictable exchange rate movement of Pakistani rupee against U.S. dollar. The variables
of this research includeGDP, export, import, foreign exchange reserve, money supply, inflation rate and
interest rate. From the period of 1971 to 2014, different exchange rate systems have been implemented
in Pakistan but since the introduction of floating exchange rate system in Pakistan the currency keeps
on devaluing against U.S. dollar. State Bank of Pakistan being the central authority has taken steps to
control devaluation of currency by adopting market based exchange rate system it was beneficial for
some time but then failed due to political instability and continuous rise in the level of inflation.
Forty-four years annual time series data incorporating forty-four total number of observations have
been used to find out the main factors affecting the exchange rate of Paksitani rupee. Graphs are drawn
to see the variations in the values over a long period of time.
Linear regression, coefficient of determination and correlation were run to find out main factors
responsible for exchange rate volatility and it was found that exchange rate is primarily affected by
GDP economic growth and export. These factors are directly related to the exchange rate as if the
export activities increases within a country it will help in increasing the value of Pakistani rupee. The
third most important variable is inflation as a high inflation reduces the value of the currency. All other
variables considered are of less importance because they are not significantly affecting exchange rate
activities in Pakistan. The result of correlation also shows that GDP is highly correlated with exchange
rate. A change in GDP results in the direct change in exchange rate.

5.2 Findings
Correlation coefficient R of 0.971that describes the association between the actual values of the
independent variables used namely GDP, inflation rate, export,import, interest rate, foreign exchange
reserves and interest rate and the dependent variable that is exchange rate of Paksitani rupee against
48

U.S. dollar.
The coefficient of determination R square is 0.943 that tells how deeply the independent variables are
affecting the exchange rate movements of Pakistani rupee against U.S. dollar.
As shown in the graph exchange rate remains stable during the period of 1973 to 1981 at a rate of 9.8
during this period the inflation and money supply was recorded lowest at an average of 7% and 9%
respectively. The exchange rate was stable due to the higher economic growth, price stability.
5.3 Conclusion:
The theme of this research project is to describe and analyze the determinants that are responsible for
the devaluation of Paksitani rupee. The current study tells that GDP economic growth rate of Pakistan
and export are the main variables that is responsible for the variations in exchange rate asit represents
the total amount of goods and services produced in a country. As more and more goods produced in a
country will increase the export which ultimately leads to an increase in exchange rate.When the export
increases the value of currency also increases devaluing other currencies. So, these two variables that
are GDP economic growth rate and export are directly and significantly related to exchange rate of
Pakistani rupee. The third important variable that directly affects the movement of exchange rate is
inflation rate. Because when the inflation rate is high the value of the domestic currency decreases
giving a rise to the value of other currencies. There is an inverse relationship between inflation rate and
exchange rate of Pakistan as high inflation rate lowers the exchange rate. These three factors are very
much accountable for the exchange rate volatility and controlling these variables is important as they
are consistently devaluing the Pakistani rupee against U.S. Dollar. The other variables are money
supply, import, foreign exchange reserve and interest rate that are also affecting exchange rate
movements with in a country.
5.4 Recommendations:

The most important fact is that the export activities in Pakistan should be increase in order to
avoid currency depreciation.

Monetary and fiscal policies must be made more effective as it will help in reducing inflation
49

and will strengthen economic growth.

The debt burden should also be reduced because increased debt burden decreases the value of
the currency and Pakistan is the country that is buried under a huge burden of debt.

Political instability also plays an important role in devaluation of Pakistani currency as it is

negatively related to exchange rate so the law and order situation must be kept stable in order to
reduce exchange rate volatility.

Despite of the factors illustrated above it is important to focus on other variables such as socioeconomic policies and political scenrios as well because their may be many other variables that are
responsible for devaluation of Pak rupee. So further study in this regard using some other variables
may be conducted to see the affect of exchange rate on Pakistani rupee against some other currency like
Euro, Yen, Rayal etc.

50

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Marialuz Morene Badia, A. S.-u. (2014). Real exchange raet appreciation in emerging markets: can
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Islamabad: Journal of Economic Cooperation.
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52

APPENDIX A
Forty-four years data is considered in this study to avoid any non-stationary problem. The study
focused on the problem of volatile exchange rates, which arises mainly due to GDP, inflation and
exports. Pakistan is a country buried under load of foreign debts and with the passing of time the debt
burden is increasing day by day which makes it less attractive for foreign investors to invest in
Pakistan. Therefore,first Pakistan should try to reduce debt burden in order to increase exports and
GDP economic growth of the country. Political instability is another major cause of currency
devaluation. The government should try to keep the law and order situation of the country under
control to avoid currency depreciation. Pakistani currency is consistently devaluing against U.S. dollar
and the central bank is making efforts to control exchange rates in order to increase the value of
Pakistani rupee. Exchange rate is the most important macro economic variable any change in the
exchange rate affects the overall economy.
Regression, coefficient of determination and correlation was runned to observe the effects of GDP,
interest rate, inflation, export, import, money supply (M2) and foreign exchange reserve on exchange
rate. It was found that GDP, export and inflation have a greater impact on exchange rate as compare to
other variables. However many other important variables are not considered due to shortage of time.
The result highlighted the facts that some variables have a direct relation with exchange rate while
other variables are inversely related to the dependent variables. Pakistani currency is continuously
devaluing just after the advent of floating exchange rate system in Pakistan so one way to overcome
this problem is to implement some other system. This research has covered a wide range of period so
that the main cause of currency devaluation can be covered.
In order to make exchange rates stable government and State Bank must concentrate on fiscal and
monetary policies because these policies helps in increasing GDP, export and in controlling the
inflation as well.

53

APPENDIX B
Hypotheses 1: Inflation is not significantly related to exchange rate.This hypotheses proved to be
wrong as inflation is strongly associated with exchange rate.

Model Summary

Model

R Square

.901

Adjusted R

Std. Error of the

Square

Estimate

.813

.808

12.70332

a. Predictors: (Constant), inflation rate of Pakistan in percentage

There exist a relationship between interest rate and exchange rate but this relationship is moderate and
not too strong. R2= 0.813> 0 and R=0.901 >0
So here H10, which means that there exist a strong relationship between interest rate and exchange
rate. This hypotheses proved to be false.

Hypotheses 2: interest rate is not significantly associated with exchange rate.This hypotheses proved to
be wrong on the basis of the following table:

Model Summary

Model
1

R
.536

R Square
a

.288

Adjusted R

Std. Error of the

Square

Estimate
.271

24.77163

a. Predictors: (Constant), interest rate of Pakistan in percentage

There exist a relationship between interest rate and exchange rate but this relationship is moderate and
not too strong. R2= 0.228 > 0 and R=0.536 >0
So here H10, which means that there exist a relationship between interest rate and exchange rate. This
54

hypotheses proved to be false.

Hypotheses 3: Import activity not significantly related to exchange rate of Pakistan.On the basis of
regression hypotheses was tested. The following tables tells that their exist a relationship bwteen
interest and exchange rate but this relation is not very strong. R2= 0.01 > 0 and R=0.099>0

Model Summary
Model
1

R Square
a

.099

Adjusted R Square
.01

-.014

Std. Error of the Estimate

29.20771

a. Predictors: (Constant), import rate in Pakistan

There exist a relationship between interest rate and exchange rate but this relationship is
moderate and not too strong. R2= 0.01 > 0 and R=0.099>0
So here H10, which means that there exist a relationship between import rate and exchange rate. This
hypotheses proved to be false.

55

56