Impact of Exchange Rate on Net Exports in Particular & On Real GDP in General

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Date of Submission: 23rd April 20, 2012 Day of Class: Monday 12:00 to 3:00

Table of Contents
INTRODUCTION .................................................................................................................................3 THEORITICAL BACKGROUND: ..........................................................................................................3 NET EXPORT: ..................................................................................................................................3 EXCHANGE RATE: ...........................................................................................................................3 TYPES OF EXCHANGE RATE: ............................................................................................................3 Floating exchange rate: .......................................................................................................3 Fixed exchange rate: ...........................................................................................................3

GROSS DOMESTIC PRODUCT (GDP): ................................................................................................3 LITERATURE REVIEW ..........................................................................................................................5 METHODOLOGY .................................................................................................................................8 DATA COLLECTION .............................................................................................................................9 DATA ANALYSIS ............................................................................................................................... 11 CONCLUSION ................................................................................................................................... 12 REFRENCES ...................................................................................................................................... 13

INTRODUCTION

THEORITICAL BACKGROUND: NET EXPORT:

The value of a country's total exports minus the value of its total imports. It is used to calculate a country's aggregate expenditures, or GDP, in an open economy.

EXCHANGE RATE:
In finance, an exchange rate (also known as the foreign-exchange rate, forex rate or FX rate) between two currencies is the rate at which one currency will be exchanged for another. It is also regarded as the value of one countrys currency in terms of another currency .

TYPES OF EXCHANGE RATE:

Floating exchange rate:
A floating exchange rate or fluctuating exchange rate is a type of exchange rate regime wherein a currency's value is allowed to fluctuate according to the foreign exchange market. A currency that uses a floating exchange rate is known as a floating currency. Belize is an example of floating exchange rate.

Fixed exchange rate:

A fixed exchange rate, sometimes called a pegged exchange rate, is a type of exchange rate regime wherein currency's value is matched to the value of another single currency or to a basket of other currencies, or to another measure of value, such as gold. A fixed exchange rate is usually used to stabilize the value of a currency against the currency it is pegged to. This makes trade and investments between the two countries easier and more predictable and is especially useful for small economies in which external trade forms a large part of their GDP.

GROSS DOMESTIC PRODUCT (GDP):

The monetary value of all the finished goods and services produced within a country's borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of

private and public consumption, government outlays, investments and exports less imports that occur within a defined territory. GDP = C + G + I + NX where: "C" is equal to all private consumption, or consumer spending, in a nation's economy "G" is the sum of government spending "I" is the sum of all the country's businesses spending on capital "NX" is the nation's total net exports, calculated as total exports minus total imports. (NX = Exports - Imports).

LITERATURE REVIEW Summary of the Research Paper Exchange Rate Economics

For many years most development economists tended to dismiss the importance of exchange rates as a facet of development policy. They took the view that most developing countries were, and were likely to remain, principally exporters of primary products, whose demand is typically inelastic. Their own demand for imports could be reduced by industrialization (import substitution), but the remaining demand for materials and capital goods was price inelastic. Accordingly devaluation was unlikely to be advantageous (the Marshall-Lerner condition was unlikely to be satisfied), so there was no point in adopting a flexible exchange rate policy. Development policy needed to focus on the real economy, not on monetary variables like the exchange rate. The exchange rate is now recognized to be a decisive link between the internal economy of a country and the international economy. Given the very limited flexibility of internal prices, the nominal exchange rate is key to determining the real exchange rate in the short and medium terms. Real exchange rates are in turn key to determining macroeconomic stability and the incentive to engage in trade. Because of these links, much professional attention has been devoted to analyzing both what actually determines exchange rates and how a government that is concerned with maximizing its nations growth rate should approach the issue of exchange rate determination. Exchange rate economics is primarily devoted to understanding what determines the level, or at least the change, in a floating exchange rate. It is now taken for granted that the exchange rate is an asset price that is determined at a level that ensures that outstanding stocks of various assets (notably those denominated in different currencies) are willingly held, whereas formerly the exchange rate was viewed as determined at a level that would equate the flow demand and supply of foreign exchange. It follows immediately that a floating exchange rate depends upon what is expected to happen in the future rather than exclusively on what is now happening or has happened in the past. The exchange rate is a forward-looking asset price. Its level has implications for the behavior of the current account of the balance of payments, but the current account influences the exchange rate only in so far as forward-looking agents realize that it will influence future asset stocks. (Of course, current account outcomes also depend on saving and investment schedules: Both income flows and exchange rates are determined simultaneously in a general equilibrium setting. These clever forward-looking agents are assumed to know these outcomes.) While exchange rate economics aim to explain the determination of the level of a floating exchange rate, it also sheds light upon the problems faced by a government that wishes to determine the value of its currencys exchange rate. It is not true that there is a 1:1 relationship between the pressures that are felt by a government attempting to fix its currencys exchange

rate and the discrepancy between the market exchange rate and the rate that would be established in a competitive market, for market pressure may be negated if a government succeeds in making credible a commitment to hold the rate unchanged. Conversely, a government that is trying to hold a fixed exchange rate but is suspected by the market of being incapable of doing so may face speculative pressures in addition to those that would be generated in a floating market. Nevertheless, any government aiming to manage its exchange rate needs to understand the forces with which it may need to contend, and exchange rate economics illuminate these forces. Literature on growth and exchange rate traditionally focused on Dutch Disease: Dutch disease obtained its name from an observation of what happened in the Netherlands following the discovery and large-scale export of natural gas in the 1970s. The export of natural gas served to enrich the inhabitants of Holland, which led them to import more and export less of goods other than natural gas. The mechanism that induced them to export less was an appreciation of the real exchange rate. The harm to the manufacturing export sector caused by a real appreciation due to abundant export earnings of some raw material thus became known as Dutch disease. Economists have ever since debated whether Dutch disease should be considered a dangerous condition to be avoided by policy measures wherever possible, or a stroke of good fortune that should be enjoyed rather than resisted. The former view is largely based on the parable of export-led growth having led to beneficial development in East Asia. One of the essential conditions for the success of that strategy has always been described as the maintenance of a competitive exchange rate. Booming exports of a raw material that caused a real appreciation would interrupt that process and (it was argued) would thus scupper the process of development.12 A country that develops successfully has in due course more chance of giving a good living standard to its whole population than most countries can hope to sustain on the basis of raw material exports.13 Maintaining a competitive exchange rate in the presence of a booming raw material-exporting sector is thus regarded as a prudent act of investment. The view that development can be promoted by keeping the exchange rate undervalued raises two issues. One, considered later, is whether and how that can be accomplished. The other is the mechanism through which a highly competitive exchange rate works its effects. However, an alternative view is more prevalent among economists.15 This view is that an increase in the value of raw material exports is just like any other increase in income: It enlarges the opportunity set available to domestic residents and should therefore be welcomed like any other improvement in the terms of trade (or indeed any improvement in productivity). Naturally an unexpected improvement will in general dictate some modification in the planned profile of development, and one expects that where the shock involves increased export earnings this will usually involve a curtailment in the size of the rest of the export sector. A real appreciation is the natural and efficient way to induce such a reduction in the size of the export industries, which is an inevitable consequence of the inward transfer of

real resources that is needed to translate increased real income into higher consumption and living standards. And the standard professional view would be that the right way to bring about such a real appreciation is via a nominal appreciation, which a floating exchange rate would allow to occur. Most economists would also expect that in these circumstances a floating exchange rate would indeed appreciate. John Williamson

METHODOLOGY
In the preparation of this report on impact of exchange rate on net exports in particular and on real GDP in general, various types of methods are used to collect data and information regarding the topic. In the literature review section, a research paper conducted by John Williamson has been summarized in order to take the main essence of the research done in February 2009. However, other methods like Internet Searching in the section of DATA COLLECTION (in form of tables), and Secondary Data Method are also used to prepare this report.

DATA COLLECTION
The table below shows the data since 1980 to 2011 of all the net exports and real GDP of Pakistan in (US $).
Fiscal Year (Jul-Jun) Yearly Average Exchange Rate (PKRs Per US $) Imports (Millions of US $) Exports (Millions of US $) Net Exports (Millions of US $) GDP of Pakistan (Billions of US $)

1980-81 1981-82 1982-83 1983-84 1984-85 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12

9.90 10.65 12.74 13.51 15.26 16.16 17.20 17.62 19.31 21.47 22.53 24.87 24.04 30.31 30.87 33.81 39.24 43.47 47.05 51.77 59.08 61.30 58.42 57.59 59.47 59.86 60.63 62.68 78.84 84.03 85.61 86.02

5,563 5,771 5,618 5,990 6,017 6,000 5,793 6,917 7,201 7,414 8,387 9,000 10,049 8,691 10,298 12,015 11,236 10,301 9,613 9,602 10,202 9,434 11,333 13,604 18,996 24,994 26,989 35,397 31,747 31,209 35,872 40,461

2,799 2,316 2,627 2,665 2,458 2,943 3,488 4,361 4,628 4,924 5,894 6,761 6,782 6,684 7,776 8,311 8,096 8,434 7,528 8,191 8,934 9,140 10,889 12,396 14,482 16,553 17,278 20,427 19,121 19,673 25,355 24,696

-2765 -3455 -2991 -3325 -3559 -3057 -2305 -2556 -2573 -2490 -2493 -2238 -3267 -2007 -2522 -3704 -3140 -1867 -2085 -1411 -1268 -294 -444 -1208 -4514 -8441 -9711 -14970 -12627 -11536 -10517 -15765

23.69 28.10 30.73 28.69 31.15 31.14 31.90 33.35 38.47 40.17 40.01 45.45 48.64 51.48 51.90 60.63 63.32 62.43 62.19 62.97 73.95 72.31 72.30 83.24 97.97 109.60 127.50 143.20 163.90 161.98 174.79 211.00

1. Graphical representation of the real GDP of Pakistan since 1980 to 2011 Values are taken from the table on the previous page
200.00 180.00 160.00 140.00 120.00 100.00 80.00 60.00 40.00 20.00 0.00 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31

Real GDP Of Pakistan

2. Graphical representation on the imports vs. exports of Pakistan since 1980 to 2011 Values are taken from the table on the previous page

Import vs. exports

40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31

Thinner lines show the imports (in US billion $).

Thicker lines show the exports (in US billion $).

DATA ANALYSIS
Imports and exports have a very crucial effect on the economy of a country. These are vital components in determining the growth or decline of the gross domestic product (GDP) of a nation. When imports are greater than exports, the real GDP of a country declines, but when exports are greater, the country has a growth in the economy. From the data collected regarding the real GDP of Pakistan since 1980 to 2011, it has been concluded that the real GDP has grown gradually since 1980, in figures, from 23.67 to 174.7 (in US billion $) which has been recorded as the peak during this time period. On the other hand, Imports have exceeded the exports since 1980 to present. E.g. in the year 2011, the imports were 35,872, and the exports were 25,355 that is quite less than the imports. Since 1980, imports have got a peak in 2011, but the exports are still less than imports in spite of also having peak in 2011. Exports have lesser value than imports during this time period. This is why net exports have been recorded as NEGATIVE since 1980 to present.

CONCLUSION
In the conclusion, it has been found out that the exchange rate is one of the most important determinants of a country's relative level of economic health. Exchange rates play a vital role in a country's level of trade, which is critical to most every free market economy in the world. For this reason, exchange rates are among the most watched; the most analyzed and governmentally manipulated economic measures. Exchange rate movements affect a nation's trading relationships with other nations. A higher currency makes a country's exports more expensive and imports cheaper in foreign markets; a lower currency makes a country's exports cheaper and its imports more expensive in foreign markets. A higher exchange rate can be expected to lower the country's balance of trade, while a lower exchange rate would increase it.

REFRENCES
http://www.investopedia.com/articles/basics/04/050704.asp#ixzz1sa4E3IZO http://www.investopedia.com/terms/n/netexports.asp#ixzz1sUThVLQd http://ideas.repec.org/a/bla/jecsur/v13y1999i1p71-106.html http://www.bis.org/repofficepubl/arpresearch200908.4.htm http://www.jstor.org/discover/10.2307/2677771?uid=3738832&uid=2&uid=4&sid=560618863 http://www.iie.com/publications/interstitial.cfm?ResearchID=884 http://www.web-books.com/eLibrary/NC/B0/B62/076MB62.html
www.sbp.org.pk/ecodata/exp_import_BOP_Arch.xls www.sbp.org.pk/ecodata/exp_import_BOP.xls www.sbp.org.pk/ecodata/HER-USDollar.xls http://www.sbp.org.pk/reports/stat_reviews/Bulletin/2012/Feb/PakistanBalancePayment.pdf http://www.tradingeconomics.com/pakistan/official-exchange-rate-lcu-per-us-dollar-period-averagewb-data.html http://www.tradingeconomics.com/pakistan/gdp