Devaluation and the Balance of Trade

Abstract

Exchange-rate flexibility is generally recommended as part of structural adjustment packages to offset balance of trade deficits.² However, according to Burton and Gilman (1991, p. 19), the IMF is eclectic. For example, if countries confront a chronic current account deficit and inflation is not a serious problem, a market-determined exchange rate may be endorsed. Alternatively, if coping with inflation is the priority, a pegged exchange rate could be recommended as a nominal anchor. Problems in the real world rarely come singly. Pakistan has struggled with both price stabilization and current account deficits. It adopted a managed float in 1982 and, as part of its structural adjustment reforms, has occasionally made discretionary changes in the exchange rate when confronted with low foreign exchange reserves, or when the value of the dollar has appreciated substantially in relation to other currencies. The obvious question is whether the evidence supports such policy action. The answer is that the evidence is decidedly mixed.

This chapter was first prepared as a paper by Shahrukh R. Khan and Safiya Aftab for the international conference on ‘Economic Liberalization in South Asia’, 30 Nov.–2 Dec. 1994, organized by the Australian South Asia Research Centre. It has been published in Economia Internationale, XLIX, no. 2, 1996. Many thanks are due to Premchandra Athukorala, Warwick McKibben, Saqib Jafarey and Tariq Banuri for comments on earlier drafts.