Existence of a J-Curve-The Case of Pakistan

In this paper an attempt has been made to identify J-curve phenomenonfor Pakistan vis-a-vis her ten major trading partners by employingdisaggregated quarterly data from 1972-1 to 2003-IV. Results from thestudy support the traditional view that devaluation leads to improvementin trade balance; but due to a very rapid impact of devaluation on tradebalance we fail to identify a J-curve. This finding fails to lend credenceto the view that devaluation can be an effective policy tool fordeveloping countries facing persistent balance of payment deficits.Furthermore, results from Granger causality test indicate that causalityruns from Pakistan s real income to trade balance. This suggests thatpolicy should be focused on improving Pakistan s real income in orderto improve trade balance. Finally, we find that increase in foreigncountry s income can also lead to improvement in Pakistan s tradebalance by increase in imports from Pakistan, provided imports exhibitan inelastic demand. The policy prescription that follows from thisfinding is that policy makers in Pakistan should pursue an active strategyof encouraging production of manufactured and semi-manufacturedgoods in order to improve the trade balance through the above channel.