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Exchange Rate and its impact on Pakistan

Exchange rate Background Foreign reserves Fluctuations in exchange rate Depreciation and appreciation Types of exchange rate Demand and supply in money market Foreign exchange market Market equilibrium Exchange rate impact Pakistan s economy !urrency rates in pakistan "olatilty of rate !urrency rate impact on Pakistan

Exchange Rate
#n finance$ the exchange rate %also kno&n as the foreign-exchange rate$ forex rate or FX rate' bet&een t&o currencies specifies ho& much one currency is &orth in terms of the other( #t is the value of a foreign nation s currency in terms of the home nation s currency( For example an exchange rate of )* +apanese yen %+P,$ -' to the .nited /tates dollar %./D$ 0' means that +P, )* is &orth the same as ./D *( The foreign exchange market is one of the largest markets in the &orld( By some estimates$ about 1(2 trillion ./D &orth of currency changes hands every day(

#n a slightly different perspective$ the exchange rate is a price( #f the exchange rate can freely move$ the exchange rate may turn out to be the fastest moving price in the economy$ bringing together all the foreign goods &ith it( The currency listed on the left is called the reference %or base' currency &hile the one listed to the right is the quote %or term' currency( There is a market convention that determines &hich is the base currency and &hich is the term currency( #n order to determine &hich the base currency is &here both currencies are not listed %i(e( both are 3other3'$ market convention is to use the base currency &hich gives an exchange rate greater than *(444( This avoids rounding issues and exchange rates being quoted to more than 5 decimal places( There are some exceptions to this rule e(g( the +apanese often quote their currency as the base to other currencies(

6uotes using a country7s home currency as the price currency %e(g($ E.8 4(91:152 ; ./D *(44 in the Euro <one' are kno&n as direct quotation or price quotation %from that country7s perspective' and are used by most countries( 6uotes using a country7s home currency as the unit currency %e(g($ E.8 *(44 ; ./D *(1:))* in the Euro <one' are kno&n as indirect quotation or quantity quotation and are

used in British ne&spapers and are also common in =ustralia$ >e& ?ealand and the Euro <one(

direct quotation@ * foreign currency unit ; x home currency units indirect quotation@ * home currency unit ; x foreign currency units

>ote that$ using direct quotation$ if the home currency is strengthening %i(e($ appreciating$ or becoming more valuable' then the exchange rate number decreases( !onversely if the foreign currency is strengthening$ the exchange rate number increases and the home currency is depreciating(

The exchange rate history of the nineteenth century highlights the importance of the gold standard in that era( From *A9B to *)*1$ the exchange rate system &as dependent on the respective currency s comparative convertibility to an ounce of gold( Co&ever$ this method of determination of the exchange rate had to be reassessed &hen the gold standard &as suspended during Dorld Dar #( The suspension of the gold standard in *)*5 &as follo&ed by a collapse of the exchange rate market( #n the early *)24s$ some countries tried to revive the gold standard to get the old exchange system back into practice( Co&ever$ the Ereat Depression hit the .nited /tates in *)2)( The devastating effects of this &ere felt by most of the developed &orld( =s a result$ all plans on the revision of the gold standard &ere abandoned(

!lose to the end of Dorld Dar ##$ the Bretton Doods =greement &as signed( /ince the impact of the Ereat Depression &as still fresh in the minds of the policymakers$ they &anted to shun all possibilities of a similar fiasco( The Bretton Doods =greement founded a system of fixed exchange rates in &hich the currencies of all countries &ere pegged to the ./ dollar$ &hich in turn &as based on the gold standard( The Bretton Doods =greement &as in effect till *)9*( By *)94$ the existing exchange rate system &as already under threat( The >ixonFled ./ government suspended the convertibility of the national currency into gold( The supply of the ./ dollar had exceeded its demand( #n *)9*$ the /mithsonian =greement &as signed( For the first time in exchange rate history$ the market forces of supply and demand began to determine the exchange rate(

The /mithsonian =greement did not last very long( By *)91$ the extensively traded currencies &ere permitted to fluctuate( #n a floating currency system$ a currency s value is allo&ed to vary in keeping &ith the conditions of the foreign exchange market( The advantage of a floating exchange rate system is that it is self attuned( = floating currency system allo&s greater liquidity and central bank control$ but can be subGect to attacks by speculators$ or sudden panicFdriven moves by investors that lead to currency crises and recessions(

Foreign Reserves
Coldings of foreign currency held by a government( = substantial foreign reserve of consistently stable currencies$ such as a reserve currency like the dollar or the Euro$ can dampen the effect of inflation or of a currency crisis( =lso called currency reserve$ forex reserve( Foreign exchange reserves %also called Forex reserves' in a strict sense are only the foreign currency deposits and bonds held by central banks and monetary authorities( Co&ever$ the term in popular usage commonly includes foreign exchange and gold$ /D8s and #MF reserve positions( This broader figure is more readily available$ but it is more accurately termed official international reserves or international reserves( These are assets of the central bank held in different reserve currencies$ mostly the ./ dollar$ and to a lesser extent the Euro$ the .H pound$ and the +apanese yen$ and used to back its liabilities$ e(g( the local currency issued$ and the various bank reserves deposited &ith the central bank$ by the government or financial institutions(

#n a flexible exchange rate system$ official international reserve assets allo& a central bank to purchase the domestic currency$ &hich is considered a liability for the central bank %since it prints the money or fiat currency as #I.s'( This action can stabili<e the value of the domestic currency( !entral banks throughout the &orld have sometimes cooperated in buying and selling official international reserves to attempt to influence exchange rates(

Changes in reserves
The quantity of foreign exchange reserves can change as a central bank implements monetary policy( = central bank that implements a fixed exchange rate policy may face a situation &here supply and demand &ould tend to push the value of the currency lo&er or higher %an increase in demand for the currency &ould tend to push its value higher$ and a decrease lo&er'( #n a flexible exchange rate regime$ these operations occur automatically$ &ith the central bank clearing any excess demand or supply by purchasing or selling the

foreign currency( Mixed exchange rate regimes %7dirty floats7$ target bands or similar variations' may require the use of foreign exchange operations %sterili<ed or unsterili<ed' to maintain the targeted exchange rate &ithin the prescribed limits %!hina has been repeatedly accused of doing this by the ./='( To maintain the same exchange rate if there is increased demand$ the central bank can issue more of the domestic currency and purchase the foreign currency$ &hich &ill increase the sum of foreign reserves( #n this case$ the currency7s value is being held do&nJ since %if there is no sterili<ation' the domestic money supply is increasing %money is being 7printed7'$ this may provoke domestic inflation %the value of the domestic currency falls relative to the value of goods and services'(


!enefits and criticisms

Karge reserves of foreign currency allo& a government to manipulate exchange rates F usually to stabili<e the foreign exchange rates to provide a more favorable economic environment( #n theory the manipulation of foreign currency exchange rates can provide the stability that a gold standard provides$ but in practice this has not been the case( =lso$ the greater a country7s foreign reserves$ the better position it is in to defend itself from speculative attacks on the domestic currency( There are costs in maintaining large currency reserves( Fluctuations in exchange markets result in gains and losses in the purchasing po&er of reserves( Even in the absence of a currency crisis$ fluctuations can result in huge losses( For example$ !hina holds huge .(/( dollarFdenominated assets$ but the .(/( dollar has been &eakening on the exchange markets$ resulting in a relative loss of &ealth( #n addition to fluctuations in exchange rates$ the purchasing po&er of fiat money decreases constantly due to devaluation through inflation( Therefore$ a central bank must continually increase the amount of its reserves to maintain the same po&er to manipulate exchange rates( 8eserves of foreign currency provide a small return in interest( Co&ever$ this may be less than the reduction in purchasing po&er of that currency over the same period of time due to inflation$ effectively resulting in a negative return kno&n as the 3quasiFfiscal cost3( #n addition$ large currency reserves could have been invested in higher yielding assets( The follo&ing is a list of the ten largest countries by foreign exchange reserves@ Billion "#$ %end of month&



People7s 8epublic of !hina %!hina'

0 2544 %Dec 244)'


0 *4*) %+un 244)'

Euro <one

0 9*B %Ict 244)'


0 55* %+an 24*4'

8epublic of !hina %Tai&an'

0 15A(2 %Dec 244)'


0 299(4 %Mar 2B$ 24*4'

/outh Horea

0 294() %>ov 244)'


0 25:(444 %Mar 24*4'

Cong Hong

0 254 %>ov 244)'


0 *A5 %/ep 244)'

*4 >otes


0 *A2 %/ep 244)'

*( !hina updates its information quarterly( 2( 8ussia and #ndia update their information &eekly and monthly( 1( Bra<il updates its information daily(

Excess reserves
Foreign exchange reserves are important indicators of ability to repay foreign debt and for currency defense$ and are used to determine credit ratings of nations$ ho&ever$ other government funds that are counted as liquid assets that can be applied to liabilities in times of crisis include stabili<ation funds$ other&ise kno&n as sovereign &ealth funds( #f those &ere included$ >or&ay and Persian Eulf /tates &ould rank higher on these lists$ and .=E 0*(1 trillion =bu Dhabi #nvestment =uthority &ould be second after !hina( /ingapore also has significant government funds including Temasek Coldings and E#!(

#ndia is also planning to create its o&n investment firm from its foreign exchange reserves(

Fluctuations in Exchange Rate

= market based exchange rate &ill change &henever the values of either of the t&o component currencies change( = currency &ill tend to become more valuable &henever demand for it is greater than the available supply( #t &ill become less valuable &henever demand is less than available supply %this does not mean people no longer &ant money$ it Gust means they prefer holding their &ealth in some other form$ possibly another currency'( #ncreased demand for a currency is due to either an increased transaction demand for money$ or an increased speculative demand for money( The transaction demand for money is highly correlated to the country7s level of business activity$ gross domestic product %EDP'$ and employment levels( The more people there are unemployed$ the less the public as a &hole &ill spend on goods and services( !entral banks typically have little difficulty adGusting the available money supply to accommodate changes in the demand for money due to business transactions( The speculative demand for money is much harder for a central bank to accommodate but they try to do this by adGusting interest rates( =n investor may choose to buy a currency if the return %that is the interest rate' is high enough( The higher a country7s interest rates$ the greater the demand for that currency( #t has been argued that currency speculation can undermine real economic gro&th$ in particular since large currency speculators may deliberately create do&n&ard pressure on a currency in order to force that central bank to sell their currency to keep it stable %once this happens$ the speculator can buy the currency back from the bank at a lo&er price$ close out their position$ and thereby take a profit'(

$epreciation and 'ppreciation

#n economics$ the terms currency appreciation and currency depreciation describe the movements of the exchange rate induced by market fluctuations(

Currency depreciation is the loss of value of a country7s currency &ith respect to one or more foreign reference currencies$ typically in a floating exchange rate system( #t is most often used for the unofficial increase of the exchange rate due to market forces$ though sometimes it appears interchangeably &ith devaluation( #ts opposite is called appreciation( The depreciation of a country7s currency refers to a decrease in the value of that country7s currency( For instance$ if the !anadian dollar depreciates relative to the Euro$ the exchange rate %the !anadian dollar price of euros' rises F it takes more !anadian dollars to purchase * Euro %* E.8;*(:!=D L * E.8;*(9!=D'( The appreciation of a country7s currency refers to an increase in the value of that country7s currency( !ontinuing &ith the !=DME.8 example$ if the !anadian dollar appreciates relative to the Euro$ the exchange rate falls F it takes fe&er !anadian dollars to purchase * Euro %* E.8;*(:!=D L * E.8;*(5!=D'( For example$ if the exchange rate bet&een the .(/( dollar and the Euro is expressed in dollars per Euro %e(g($ *(24 dollars per Euro'$ an increase in the exchange rate %e(g($ to *(2: dollars per Euro' means that the dollar depreciates &ith respect to the Euro and the Euro appreciates &ith respect to the dollar( #n other &ords$ the dollar becomes less valuable and the Euro becomes more valuable( The same exchange rate can be expressed in euros per dollar %e(g($ 4(A1 euros per dollar'( #n this case$ an increase in the exchange rate %e(g($ to 4() euros per dollar' means that the dollar appreciates &ith respect to the Euro and the Euro depreciates &ith respect to the dollar(

(ays to express
Exchange rate prices are expressed in various &ays@ #pot Exchange Rate F the spot rate is the actual exchange rate for a currency at current market prices( This is determined by the FI8EN market on a minuteFbyFminute basis on the basis of the flo& of supply and demand for any one particular currency( For)ard Exchange Rate F a for&ard rate involves the delivery of currency at some time in the future at an agreed rate( !ompanies &anting to reduce the risk of exchange rate uncertainty by buying their currency Ofor&ard on the market often use this( Bi-lateral Exchange Rate F this is simply the rate at &hich one currency can be traded against another( Examples include@ 0MDM$ /terlingM./ Dollar$ 0M,E> or /terlingMEuro Effective Exchange Rate *ndex %EER& F the EE8 is a &eighted index of sterling7s value against a basket of international currencies the &eights used are determined by the proportion of trade bet&een the .H and each country

Real Exchange Rate F this measure is the ratio of domestic price indices bet&een t&o countries( = rise in the real exchange rate implies a &orsening of international competitiveness for a country(

Exchange rate systems

/ince an exchange operates in different types of exchange rate systems$ it is fundamental to understand &hat these are( Cere is a description of the different types of exchange rate systems(

Floating exchange rate

= floating exchange rate or fluctuating exchange rate is a type of exchange rate regime &herein a currency7s value is allo&ed to fluctuate according to the foreign exchange market( = currency that uses a floating exchange rate is kno&n as a floating currency( ( =s floating exchange rates automatically adGust$ they enable a country to dampen the impact of shocks and foreign business cycles$ and to preempt the possibility of having a balance of payments crisis( Co&ever$ in certain situations$ fixed exchange rates may be preferable for their greater stability and certainty( This may not necessarily be true$ considering the results of countries that attempt to keep the prices of their currency 3strong3 or 3high3 relative to others$ such as the .H or the /outheast =sia countries before the =sian currency crisis( #n cases of extreme appreciation or depreciation$ a central bank &ill normally intervene to stabili<e the currency( Thus$ the exchange rate regimes of floating currencies may more technically be kno&n as a managed float( = central bank might$ for instance$ allo& a currency price to float freely bet&een an upper and lo&er bound$ a price 3ceiling3 and 3floor3( Management by the central bank may take the form of buying or selling large lots in order to provide price support or resistance$ or$ in the case of some national currencies$ there may be legal penalties for trading outside these bounds(

Fixed exchange rate

= fixed exchange rate is a type of exchange rate regime &herein a currency7s 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(

= fixed exchange rate is usually used to stabili<e the value of a currency$ against the currency it is pegged to( This makes trade and investments bet&een the t&o countries easier and more predictable$ and is especially useful for small economies &here external trade forms a large part of their EDP( #t can also be used as a means to control inflation( Co&ever$ as the reference value rises and falls$ so does the currency pegged to it( #n addition$ according to the MundelFFleming model$ &ith perfect capital mobility$ a fixed exchange rate prevents a government from using domestic monetary policy in order to achieve( #emi fixed rate is the exchange rate is given a specific target The currency can move bet&een permitted bands of fluctuation on a dayFtoFday basis Exchange rate becomes an target of economic policyFmaking %interest rates are set to meet the exchange rate target'( Fully fixed rate is &hen government makes a commitment to a fixed exchange rate( The exchange rate is pegged( There are no fluctuations from the central rate( /ystem achieves exchange rate stability but perhaps at the expense of domestic stability( = country can automatically improve its competitiveness by reducing its costs belo& that of other countries P kno&ing that the exchange rate &ill remain stable

Pegged exchange rate

=n exchange rate for a currency in &hich the government has decided to link the value to another currency or to some valuable commodity like gold( For example$ under the Bretton Doods /ystem$ most &orld currencies pegged themselves to the .(/( dollar$ &hich in turn pegged itself to gold( = government may peg its currency by holding reserves of the peg in the central bank( For example$ if a country pegs its currency to the British pound$ it must hold enough pounds in reserves to account for all of its currency in circulation( #mportantly$ pegged exchange rates do not change according to market conditions(

$eficit financing
#n government$ the practice of spending more money than is received as revenue$ the difference being made up by borro&ing or minting ne& funds( The term usually refers to a conscious attempt to stimulate the economy by lo&ering tax rates or increasing government expenditures( !ritics of deficit financing regularly denounce it as an example of shortsighted government policy( =dvocates argue that it can be used successfully in response to a recession or depression$ proposing that the ideal of an annually balanced budget should give &ay to that of a budget balanced over the span of a business cycle( Deficit financing stimulates the economy for a time but eventually can become a drag on the economy by pushing up interest rates(

$emand and supply in money market

The foreign exchange %or Forex' market$ Gust like every other market in the &orld$ is driven by supply and demand( #n fact$ understanding the concept of supply and demand is so important in the Forex market( /upply is the measure of ho& much of a particular commodity is available at any one time( The value of a commodityFFa currency in this caseFFis directly linked to its supply( =s the supply of a currency increases$ the currency becomes less valuable( !onversely$ as the supply of a currency decreases$ the currency becomes more valuable( In the other side of the economic equation$ &e find demand( Demand is the measure of ho& much of a particular commodity people &ant at any one time( Demand for a currency has the opposite effect on the value of a currency than does supply( =s the demand for a currency increases$ the currency becomes more valuable( !onversely$ as the demand for a currency decreases$ the currency becomes less valuable(


The supply of money goes up.


The supply of goods goes down.


Demand for money goes down.


Demand for goods goes up.

$emand and #upply of Foreign Exchange influences the determination of exchange rates and vice versa( The demand for foreign exchange is inversely proportional to the rise of exchange rate( =s the exchange rate goes up the demand for foreign exchange declines( The quantity of foreign exchange demanded falls( The supply of foreign exchange shifts depending on demand and not on the exchange rate( #f the supply aspect

of transaction is plotted on a graph it &ill be vertical since the supply of foreign currency deposits available at any time is fixed( #f the supply of a country s currency increases the value of the currency decreases in relation to other currencies and more money is required to buy the foreign exchanges

Foreign Exchange +arket

The transaction of a currency takes place in the foreign exchange market( The supply of a currency depends on the ups and do&ns of the market( #n the market large financial institutions and banks trade &ith money(

Factors =ffecting Demand and /upply of Foreign Exchange

The supply and demand of foreign exchange depends on lots of factors( They are@ Q Economic Factors that include economic policies formulated by central Banks and government agencies$ economic reports$ conditions and other economic indicators( Q Political conditions &ithin and around the country also affect the currency market( 8egional$ central and international politics cast a profound effect on the currency market( Q The Market Psychology and the perception of the traders and buyers also affect the currency market in various &ays( =ll these factors affect the currency market and in turn the supply and demand of foreign exchange falters(

E,uili!rium in the Foreign Exchange +arket

Dhatever the exchange rate may be the aim of &orld economy is to maintain equilibrium( The foreign exchange market is considered to be in equilibrium &hen the deposits of all the currencies provide equal rate of return that &as expected( The Basic Equilibrium condition depends on interest rate parity( The interest rate parity condition is achieved &hen the anticipated returns on deposits of any t&o currencies are same &hen evaluated in the same currency( This essentially means that the assets are valued as equals( The potential foreign currency holders perceive all of them as equally desirable assets

Exchange rate impact

#n the current economy$ the dollar is relatively strong compared to other currencies( This makes imports cheap$ &hich reduces inflation( This lo&ers the cost of living$ allo&ing you to buy more FF or save more$ thus enhancing your personal finances( .nfortunately$ a strong dollar also means that .(/( companies can export less since their products cost more relative to foreign products( Iver time$ this slo&s economic gro&th( #t also causes companies to source Gobs overseas$ &here foreign &orkers cost less since they are paid in relatively &eaker currencies( In the other hand$ if the dollar declines$ this erodes the value of your personal finances( That is because import prices &ill start to rise$ causing inflation that &ill lo&er the value of your cash holdings( In the other hand$ a &eak dollar could help exports$ &hich &ould strengthen the economy and bring Gobs back to the .(/( in the long run( The relationship bet&een interest rates$ and other domestic monetary policies$ and currency exchange rates is complex$ but at the core it is all about supply and demand( #nterest rates influence the return or yield on bonds( Because$ for example$ .(/( Treasury bonds can only be bought in .(/( dollars$ a high interest rate in the .(/( &ill create demand for dollars in &hich to purchase those bonds( = lo& interest rate$ relative to other maGor economies$ &ill reduce demand for dollars$ as investors move to&ard higher yielding investments( =t least$ this is true in normal periods of economic expansion( This has a direct effect on the consumer price index( For example$ an appreciation of the exchange rate usually reduces the sterling price of imported consumer goods and durables$ ra& materials and capital goods( The effect of a changing currency on the prices of imported products &ill vary by type of import and also the price elasticity of demand &hich is influenced by the extent of competition &ithin individual markets(

*nflation rate is often considered as a determinant of the exchange rate as &ell( = high inflation should be accompanied by depreciation( The more so if other countries enGoy lo&er inflation rates$ since it should be the difference bet&een domestic and foreign inflation rates to determine the direction and the scale of exchange rate movements( /ome economists believe that the exchange rate influences the po&er of employees to bargain for increases in real &ages( Dhen the exchange rate is high$ there is pressure on businesses to control their costs of production in order to remain competitive P this may lead to do&n&ard pressure on &age inflation (

Balance of Payments
The balance of payments can highlight pressures for devaluation or revaluation$ reflected in large and systematic trend of foreign currency reserves at the central bank( #n particular$ large inflo&s$ due for instance to a rise in the &orld price of main export items$ tend to raise the exchange rate( !onversely$ a collapse in the trust of government to manage the economic conditions might provoke a flight of capital$ the exhaustion of foreign currency reserves and force devaluation M depreciation(

Best Exchange Rate

The !est currency for trading in the forex market is determined by technical analysis( Technical analysis is the process of measuring the value of a currency by monitoring historical price and volume trends( #t also helps to establish the future price movements of various currencies and financial instruments( =n investor finds the best exchange rates as follo&s@ Plan &ith care before investing in forex and by setting up potential entry and exit points( Base the entry and exits strategies on support and resistance levels of the currency in forex( Penetrate the market &hen minor corrections occur in a currency s trend( These corrections or Oretracements may be in the form of a pullback in an uptrend or vice versa(

-he glo!al foreign exchange market

-he "# dollar as the leading currency
#n the international foreign exchange market$ the ./ dollar is the dominating currency$ the euro$ ne&ly established in *)))$ coming in second place( If the total transactions in the international currency markets$ A) percent have the ./ dollar on one side of the transaction$ 19 percent the euro( The yen and the sterling follo& &ith 24 respectively *9

percent( The daily average turnover on the foreign exchange market amounts to ./0 *() trillion %=pril 2445'( This figure is adGusted for double countingJ the gross turnover is ./0 2(9 trillion( /pot market transactions account for ./0 B24 billion$ outright for&ards for ./0 24A billion$ foreign exchange s&aps for ./0 )55 billion( The average daily turnover in the overFtheFcounter derivatives market is ./0 2(5 trillion( The by far most traded currency pair in 2445 &as the dollarMeuro P amounting to 2A percent of global turnoverJ the dollar Myen accounted for *9 percent and the dollarMsterling for *5 percent %all data@ Bank for #nternational /ettlements$ March 244:'(

Pakistan as an under developed country

Pakistan$ an impoverished and underdeveloped country$ has suffered from decades of internal political disputes and lo& levels of foreign investment( Bet&een 244*F49$ ho&ever$ poverty levels decreased by *4R$ as #slamabad steadily raised development spending( Bet&een 2445F49$ EDP gro&th in the :FAR range &as spurred by gains in the industrial and service sectors F despite severe electricity shortfalls F but gro&th slo&ed in 244AF4) and unemployment rose( #nflation remains the top concern among the public$ Gumping from 9(9R in 2449 to 24(AR in 244A$ and *5(2R in 244)( #n addition$ the Pakistani rupee has depreciated since 2449 as a result of political and economic instability( The government agreed to an #nternational Monetary Fund /tandby =rrangement in >ovember 244A in response to a balance of payments crisis$ but during 244) its current account strengthened and foreign exchange reserves stabili<ed F largely because of lo&er oil prices and record remittances from &orkers

abroad( Textiles account for most of Pakistan7s export earnings$ but Pakistan7s failure to expand a viable export base for other manufactures have left the country vulnerable to shifts in &orld demand( Ither long term challenges include expanding investment in education$ healthcare$ and electricity production$ and reducing dependence on foreign donors( .$P% official exchange rate&: 0*BA(: billion %244) est(' Reserves of foreign exchange and gold: 0*:(BA billion %1* December 244) est(' country comparison to the &orld@ 5B 0A()41 billion %1* December 244A est(' Exchange rate: Pakistani rupees %PH8' per ./ dollar F A*(5* %244)'$ 94(B5 %244A'$ B4(B2): %2449'$ B4(1: %244B'$ :)(:*: %244:' The /tate Bank of Pakistan %/BP'$ the central bank$ controls the money supply and credit$ supervises the operations of banks$ administers the country7s international reserves$ and acts as banker to the federal and provincial governments( The government of Pakistan has follo&ed a liberal monetary policy in order to provide cheap credit to the industrial sector( The demand for credit$ ho&ever$ has not come forth from the private sector( =lthough domestic credit expansion &as higher due to large borro&ing by the government sector$ conversion of nonFresident foreign currency accounts into rupees$ and an increase in liquid reserves$ actual gro&th in money supply has remained stagnant due to lo& credit demand from the private sector( The government and the /BP are attempting structural reforms in an effort to move to&ard more indirect$ marketFbased methods of monetary control along &ith greater autonomy for the /BP( The central bank7s autonomy &as considerably strengthened &ith the passage of ne& banking la&s in the /tate Bank =ct in May *))9(

There are 1 stock exchanges in Pakistan@ Harachi$ Kahore$ and #slamabad( Kahore and #slamabad stock exchanges are substantially smaller than Harachi(

/arachi #tock Exchange

The /arachi #tock Exchange or /#E is a stock exchange located in Harachi$ /indh$ Pakistan( Founded in *)59$ it is Pakistan7s largest and oldest stock exchange$ &ith many Pakistani as &ell as overseas listings( ( #t &as declared the SBest Performing /tock Market of the Dorld for the year 2442T( =s of Dec A$ 244)$ B:5 companies &ere listed &ith a market capitali<ation of 8s( 2(:B* trillion %./0 14(: billion' having listed capital of 8s( 94:(A91 billion %./0 *4(B*: billion'( The H/E *44TM #ndex closed at *425B on =pril 4*$ 24*4( The Harachi stock exchange has undergone a considerable deal of do&nturn partly due to global financial crisis and partly on account of domestic troubles( #t remained suspended in excess of 5 months and resumed normal trading only on December *:$ 244A( The H/E *44 #ndex and H/E 14 #ndex after hitting the lo& around mid +anuary has no& rebounced and recovered 24F2:R till March *2 244)(

Currency rates in Pakistani rupees

Cere is chart sho&ing latest exchange rate in Pakistan
Currency Australian Dollar Bahrain Dinar Canadian Dollar China Yuan Danish Krone Euro Hong Kong Dollar !ndian "u#ee $a#anese Yen Ku%aiti Dinar &ala'sian "inggit (e%)ealand * (or%egians Krone +,ani "i'al Symbol Buying 77.9 223.1 82.9 12.2 15 113.2 1 .7 1.75 .9 288 24.2 57.5 14 218.3 Selling 78.9 225 83.9 13.3 15.5 114.3 11 1.85 .91 291 25.7 58.58 14.2 22 .85 Charts

=.D BCD !=D !>, DHH E.8 CHD #>8 +P, HDD M,8 >?D >IH IM8

-atari "i'al .audi "i'al .inga#ore Dollar .%edish Korona .%iss 0ran1 2hai Bhat 3.A.E Dirha, 3K 4ound .terling 3. Dollar

6=8 /=8 /ED /EH !CF TCB =ED EBP ./D

22.9 22.23 59./ 11.5 78.3 2.4 22.73 128 84

23 22.45 / ./ 11.7 79 2./ 22.95 129.2 84.3

Currency rate volatility

The impact of exchange rate volatility on the volume of international trade has been studied intensively since the late *)94 s &hen the exchange rate moved from fixed to flexible exchange rate$ means facing a volatile real exchange rate( The theory says that higher exchange rate volatility &ill reduce trade by creating uncertainty about future profit from export trade( By using the for&ard markets and by managing the timing of payments and receipts the firm can reduce the uncertainties in the short run( #n the long run$ exchange rate volatility may also affect trade indirectly by influencing firm s investment decision( Co&ever$ the commercial investors have limited possibilities of trading claims to future operational cash flo&s( Thus they are forced to shift a&ay from risky markets( =ccording to these arguments$ traders are risk averse$ and hedging is expensive or impossibleJ therefore$ exchange rate volatility &ill reduce risk adGusted profit from foreign trade(

Pakistan0s exchange rate

Pakistan follo&s the flexible exchange rate system since *)A2( =t the initial stage the fluctuation of exchange rate is very nominal( Co&ever$ exports evolved broadly in line &ith total &orld imports( Pakistan s share in &orld imports &as stable during the last 25 years$ ranging bet&een a minimum of 4(*2 percent in *)A4 and a maximum of 4(*A percent in *))2( #n 2442F2441 the share &as 4(*9 percent( This suggests that Pakistan s exports performance &as based on the volatility of exchange rate( Inly one empirical study is available regarding to Pakistan s context( Humar and Dha&an %*))*' estimated the exchange rate volatility on Pakistan exports to the developed &orld from *)95 to *)A:( They found that volatility of exchange rate adversely effect on export demand( They also investigated the third country effect and suggested that +apan and Dest Eermany act as the alternate market for Pakistan s export to the .nited /tates and .nited Hingdom(

Kike most developing countries$ in Pakistan also$ the domestic price level started rising from the midF*)94s( The exchange rate started depreciating continuously from the early *)A4s( !ontinuous devaluation of currency and inflation in the *)A4s seems to suggest a correlation bet&een the t&o variables( #n most of the developing countries flexibility of exchange rate is favored on the ground that it depolitici<es the problem of devaluation and creates less disruption in the economy( =nother adverse impact may be that real exchange rate may remain stable but in some instances lead to antiFexport bias( /ince *)A2 the Pak rupee has been characteri<ed by a managed floatJ the rupee &as pegged to a basket of currencies &ith the ./ dollar being the main anchor currency( #n +uly 2444 this system &as replaced by a free float( Co&ever$ &e can argue that in practice regular /tate Bank of Pakistan %/BP' intervention continues$ and therefore the issues of real depreciation to correct the trade balance still remain relevant(

Exchange rate impact

The monetary policy in Pakistan aims at stabili<ing the domestic and external value of the currency and to foster economic gro&th( Therefore$ the exchange rate passFthrough to domestic &holesale and consumer prices is an important link in the process of monetary policy transmission( /ince Pakistan s economy has a considerable degree of openness to foreign trade$ the domestic price level cannot remain immune to external price shocks i(e( exchange rate depreciationMappreciation and changes in import prices( =ny appreciation or depreciation of the exchange rate &ill not only result in significant changes in the prices of imported finished goods but also imported inputs that affect the cost of the finished goods and services /pecifically$ exchange rate movements can influence domestic prices through direct and indirect channels( ( #n case of direct channel$ exchange rate movements can affect domestic prices through changes in the price of imported finished goods and imported inputs( #n general$ &hen a currency depreciates it &ill result in higher import prices &hile lo&er import prices result from appreciation in price taker countries like Pakistan( The potentially higher costs of imported ra& material and capital goods associated &ith an exchange rate depreciation increase marginal costs and lead to higher prices of domestically produced goods( #n case of indirect effect$ the exchange rate depreciation affects the net exports &hich in turn influence the domestic prices through the change in aggregate demand$ putting up&ard pressure on domestic prices( #n addition$ importFcompeting firms might increase prices in response to foreign competitor price increases in order to maintain profit margins( Co&ever$ the extent and the speed of exchange rate passFthrough depends on several factors such as market structure$ pricing policies$ general inflationary environment$ involvement of nonFtradable in the distribution of tradable$

Cence it is concluded that exchange rate sho&s the value of one currency &ith respect to other( !urrency rate is very helpful in determining value of country s currency in money market( The exchange rate is a conversion factor$ a multiplier or a ratio$ depending on the direction of conversion(

Demand and /upply of Foreign Exchange influences the determination of exchange rates and vice versa( ( = currency &ill tend to become more valuable &henever demand for it is greater than the available supply( #t &ill become less valuable &henever demand is less than available supply Fluctuations in the exchange rate exert a po&erful impact on exports$ imports and the trade balance( = high and rising exchange rate tends to depress exports$ to boost import and to deteriorate the trade balance$ as far as these variables respond to price stimuli( !onsumers find foreign goods cheaper so the consumption composition &ill change( /imilarly$ firms &ill reduce their costs by purchasing intermediate goods abroad( Pakistan follo&s the flexible exchange rate system since *)A2( #n +uly 2444 this system &as replaced by a free float( #n Pakistan$ the exchange rate passFthrough to domestic &holesale and consumer prices is an important link in the process of monetary policy transmission( /pecifically$ exchange rate movements can influence domestic prices through direct and indirect channels( Exchange rate fluctuation is an indication of country s economic condition at present(