DRIVERS OF EXCHANGE RATE FLUCTUATIONS IN PAKISTAN: ECONOMETRIC EVIDENCE USING ARDL AND TAR MODELS

Abstract

This study investigates the key drivers of exchange rate fluctuations in Pakistan over the period 1990–2022. A single equation econometric modeling framework, incorporating the Autoregressive Distributed Lag (ARDL) approach, is employed to examine the determinants of the exchange rate. The explanatory variables considered include gross domestic product, inflation rate, terms of trade, exports, imports, foreign direct investment, and general government expenditures. The short run ARDL estimates reveal that a decline in the demand for imported goods and an expansion in government expenditures contribute to short term improvements in the exchange rate. In the long run, the findings indicate that rising inflation and an increasing import bill exert downward pressure on the value of the Pakistani rupee. Conversely, improvements in the terms of trade, growth in exports, higher inflows of foreign direct investment, and increased government expenditures play a significant role in strengthening the currency. These results underscore the importance of targeted macroeconomic policies aimed at controlling inflation, managing import dependence, and enhancing external sector performance to stabilize Pakistan’s exchange rate over time. The application of Autoregressive Threshold Analysis (TAR) indicates that regimes characterized by high economic growth, low inflation, improved terms of trade, elevated export volumes coupled with reduced import volumes, higher inflows of foreign direct investment, and increased government budgetary expenditures are vital for strengthening the value of the Pakistani rupee (PKR).