Impact of Devaluation on Balance of Trade: A Context of Neighboring Countries

Abstract

Currency devaluation plays an important role in reshaping trade balance counties like China and Malaysia have experienced export-led growth based on maintenance of their devalued currencies. This study provides the effect of recent currency devaluation of Pakistan on its trade with neighboring countries namely China, India, and Iran. The countries are of remarkable importance because the trade climate of the region is in transition in the essence of China-Pakistan Economic Corridor (CPEC). The paper adopts the elasticity approach to test the effect of devaluation by examining Marshall-Lerner condition. The study uses Panel data estimation models to determine import and export elasticities which serve as inputs for Marshall-Lerner condition. The data of monthly frequency is analyzed over the period of January 2005 to May 2018. The empirical results show that Marshall-Lerner condition does not hold for Pakistan bilateral trade to China and India, however, fulfilled for Iran. It suggests that devaluation of December 2017 of PKR has improved the trade balance of Pakistan with Iran but deteriorated with India and China. The results of the study would allow us to understand the cost and benefits of regional trade integration.