How Democratic and Military Regimes and Monetary Parameters Influenced Exchange Rate Over Fifty Years of Existence in Pakistan

Abstract

This paper aims to find out how far the types of governance – democratic and military regimes and macroeconomic variables such as interest rate, inflation rate – founded in purchasing power parity theory, and foreign debt and foreign reserves – founded in the balance of payment theory, act as determinants of the exchange rate in Pakistan. The time period covered by this paper encompasses from 1971 to 2019 where annual (year-end) data has been used. A nominal (dummy) variable has been incorporated for the type of government with a benchmark of the democratically elected government. Maintaining a fair level exchange rate is a point of concern for policymakers all over the world. This is for the reason that the foreign exchange rate not only affects exports and imports – the balance of payment, but also can influence the inflation in the country. Pakistan being a net importing country can witness that after 2018 a great deal of inflation is caused by a drastic depreciation of PKR. High foreign exchange reserves and a low level of foreign debt can get a country better financial standing in the global financial fraternity and can get better risk rating from international rating agencies spurring high foreign direct investment and low-cost borrowing from multilateral agencies. Eviews software was used to run regression and Auto-Regressive Distributed Lag Model (ARDL) with Bound test to understand the short- and long-term relationships. We find that the exchange rate remains relatively stable during military regimes. Interest rate positive and insignificant; inflation rate negative but insignificant; foreign reserves negative and significant; and foreign debt positive and significant determinants of the
exchange rate.