J-curve Analysis of Pakistan with D-8 Group

This study aims to investigate that whether or not exchange rate depreciation has impact on trade balance of Pakistan when it is trading with developing eight countries (D-8). Jcurve theory of trade postulates that initially, on depreciation of a country’s currency, it deteriorates the trade balance, however, in long run when adjustments are taken place the trade balances improves. Actually, the depreciation makes the foreign goods (imports) expensive for the home country and domestic goods (exports) cheaper for the rest of the world. Consequently, it improves the balance of trade, hence the balance of payment of a country. This study uses the quarterly data from 2005QI to 2014QIV to assess the effects of exchange rate on balance of trade of Pakistan to investigate the J-curve phenomenon in the case of Pakistan with D-8 group. A relatively new empirical estimation technique of ARDL has been applied along with Granger Causality test. Hence, the empirical results of this study found a long run positive significant impact of exchange rate depreciation on trade balance along with a short run negative significant effect. Therefore, these finding support the existence of J-curve in the case of Pakistan with D-8. It is concluded that depreciation policy may be used as a policy tool to correct the deficit in balance of trade of Pakistan especially when trading with developing economies.