FEW economic issues provoke as much debate in Pakistan as the effect of the exchange rate on exports and the effectiveness of monetary policy when inflation is driven by supply-side factors. For now, we’ll focus on the nexus between the exchange rate and exports. While export-led growth remains a popular theme in policy discussions, an anti-export bias persists in practice. Unsurprisingly, despite decades of repeated policy failures, our approach to managing balance-of-payments remains unchanged. Policymakers have yet to accept that a market-based exchange rate and foreign exchange liberalisation are essential ingredients of a successful export strategy.
Two arguments are usually made to downplay the role of the exchange rate. The first is that the rupee has lost considerable value over the past several years, yet exports have remained stagnant. The second is that Pakistan’s export industries rely heavily on imported raw materials, meaning that currency depreciation increases input costs and thus dilutes any competitive gains.
Export growth critically depends on competitiveness, ie, the ability to produce and sell goods and services in international markets at prices and quality that outperform competitors. The determinants of competitiveness can broadly be divided into two categories: price factors and non-price or structural factors. Among the price factors, the real effective exchange rate is the most widely used measure of competitiveness. Maintaining a sound REER is important not only for exports but also for overall external-sector stability. A prudent policy, therefore, allows the nominal exchange rate to adjust over time to offset inflation differentials with trading partners and ensure a broadly stable REER.
Pakistan, however, has often followed the opposite approach. Instead of allowing the nominal exchange rate to reflect economic fundamentals, policymakers attempt to keep it artificially stable while allowing the REER to rise. As the Punjabi poet Ustad Daman said: “Iss jag di ulti ganga vich/ Phul dubda, pathar tarda ae” (‘In this world with river Ganga running upside down; the flower sinks, while the stone floats’). It is a great metaphor for how good things suffer and bad things prevail in a system.
Policymakers try to keep the exchange rate artificially stable.
The State Bank reports REER data on its EasyData portal, which is publicly accessible. An empirical analysis, using data covering the past five decades and controlling for inflation and real GDP growth, finds that an increase in the REER is followed by weaker export performance and a deterioration in the trade balance. By contrast, nominal depreciation of the currency improves the trade balance mainly by compressing imports. The estimated models explain more than 50 per cent of the variation in the trade balance ratio. The evidence, therefore, suggests that both the real and nominal exchange rates have considerable explanatory power for the trade balance. This is not merely a suggestion by exchange rate zealots.
Regarding imported raw materials, it should be noted that this is not something specific to Pakistan’s export sector. Modern manufacturing throughout the world is characterised by global value chains. Imported components are an integral part of export production in almost every country. That said, it is important to consider the dynamics of the imported input cost channel for export competitiveness.
Global increases in the dollar prices of imported inputs affect all competing producers with similar cost structures and comparative advantages, making such shocks broadly neutral from a competitiveness standpoint. Likewise, when the rupee depreciates, it simultaneously raises the local cost of imported inputs and the rupee value of export receipts. This dual effect implies that exporters’ net profit margins may remain broadly unchanged. Thus, the cost of imported inputs may not significantly affect export competitiveness; rather, domestic factors, including energy costs, taxes, regulatory burdens and other non-price considerations, play a more decisive role.
The exchange rate debate, however, extends beyond exports. An artificially overvalued currency renders imports cheaper, thereby putting pressure on the trade balance, and distorts resource allocation across the economy. It also suppresses the rupee value of legal remittances inflows, while benefiting illicit financial flows, including money laundering.
The lesson is straightforward. Exports certainly need enhanced productivity, logistics, technological sophistication and institutional quality, yet these must be complemented with a competitive exchange rate. A country that aspires to build an export-driven economy must first allow its currency to discover its true price.
The writer is an economist.
m.farooqarby@gmail.com
Published in Dawn, August 1st, 2026