Impact of Currency Devaluation on Trade Balance of Pakistan

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Impact of Currency Devaluation on Trade Balance of Pakistan

In a developing country large amount of exports consist of primary commodities and exports earnings due to the relative inelasticity of supply and uncertain production levels of primary goods, are not only unpredictable, but also vulnerable to a number of factors. The developing countries also depend upon the advanced industrial countries for most of their developmental needs (technology, capital, and producer goods) and consumption requirements. The developing countries, therefore, find their external environment to be vulnerable to their terms of trade deteriorating, and the trade and payments gaps widening with the passage of time, and persistent current account deficit. According to economic theory, it is stated that currency depreciation improves the trade balance, but only after a passage of time, which means that the impact of currency devaluation on trade balance is not instantaneous. There is enough evidence in the literature that after currency depreciation, the trade balance worsens in the short run, before improving in the long run. The pattern of the movement of the trade balance over time resembles the letter J and called J-Curve phenomenon. The J-Curve phenomenon has been explained by several factors. Magee (1973) illustrated the phenomenon as consisting of a period during which contracts already in transit in specified currencies and at old prices dominate the short run (SR) response of the trade balance. Overtime new contracts are made after devaluation begins to dominate and the “pass-through” of the devaluation or depreciation is achieved . Junz and Rhomberg (1973) identified at least five lags between devaluation and its ultimate impact on trade balance. They argued that if the trade balance was deteriorating before devaluation, it would continue to deteriorate even after devaluation until these lags are realized and trade balance begins improving . It has also been...
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