Export Price Competitiveness and
Exchange Rate Risk in Pakistan’s
Manufacturing Sector
Uzma Zia
Pakistan Institute of Development Economics
Introduction

The globalization of markets involves intensification of
international competition that is forcing countries to be
competitive in export markets.

Competitiveness concerns stand high on the agenda of
national governments and the concept of competitiveness
has attracted a lot of attention.

Improved competitiveness of economies in general and
firms and their products in particular is a need of the day.

The ability of products/firms to compete in the world
market is a major concern for policy makers.
Contd…

Competitiveness assessments are important in
evaluating a country’s macro economic performance
and for evaluating sustainability of its policies.

Various measures to estimate competitiveness
 Trade Related (RCA,CMS)
 Productivity Related (TFP)
 Efficiency Related (Stochastic Production
Functions)
 Price Related (Relative Trade Prices, Unit Labour
Cost, Real Effective Exchange Rate)
Objectives
Main aim is to study export-price competitiveness of
Pakistan’s manufacturing sector and motivation
comes from my earlier work by cointegration
analysis on this issue.
More specific objectives are:

To analyze Pakistan’s trade pattern and factors
affecting export-price competitiveness.

To see effects of exchange rate volatility/risk on
export-price.
Assessment of Export-Price
Competitiveness
Export-Price Competitiveness is mainly assessed by
the following :
Import prices
 Unit labour cost
 Exchange rate

Exchange Rate Volatility/Risk




Exchange rate volatility play an important role in
export performance.
Increased volatility in exchange rate is assumed
to result in increased uncertainty about future
profitability of a firm/exporter.
The volatility has an impact on decisions of the
firms that are engaged in trade, if the firms are
risk averse.
Standard theory assumes that exchange rate risk
depresses international trade.
Review of Studies available internationally and for Pakistan on measuring Competitiveness
Country
Study Period
Method/Technique
Remark
Mehmood (2004)
Pakistan
1990-2000
Trade related measure:
Revealed comparative
advantage (RCA) approach.
Analyzed
Ara (2004)
Pakistan
1972-73 to 2002-03
Trade related measure:
Revealed comparative
advantage (RCA) approach.
Assessed
Hanif and Jafri
(2006)
Pakistan
1974-2004
Trade related measure:
Balassa Index
Explored
Chowdhury, (2005)
Bangladesh,
India, Pakistan
and Srilanka
1960-2000
Price related measure:
Construction of real exchange
rate indices.
Measured
Brunner and Cali
(2006)
South Asian and
OECD countries
1991-2002
Price related measure /Unit value
method:
Comparative analysis
Analyzed
Abeysinghe and
Yeok (1998)
Singapore
1980-1993
Price related measure:
Price Competitiveness
method
Empirically
Harding (2001)
Australia
1970-2000
Price related measure:
Price
Competitiveness
method and
Real Trade Weighted
Index of Exchange rate
Assessed
Fang and Miller
(2007)
Singapore
1979-2002
Price related measure:
Price Competitiveness
method
Finds
Lakshmanan (2007)
India
1980-81 to 2003-04
Price related measure:
Price Competitiveness
method
Provides
Chowdhury (1993)
G-7 countries
1973-1990
Price related measure:
Price Competitiveness
method
Examines
Author
comparative advantage
and disadvantage of Pakistan’s non
agriculture production sectors
cost competitiveness of
manufacturing sector of Pakistan
relationship of financial
sector
development
and
international trade competitiveness
in Pakistan
intra-regional
and
international trade competitiveness
for four SAARC nations
export competitiveness
and export quality of South Asian
countries manufacturing relative to
OECD countries
shows
competitiveness in Singapore
export
Australia’s
price
competitiveness and structural change
relationship between exchange
rate depreciation and exports in
Singapore
analytical
parameters
of
competitiveness in India
analysis
of
manufacturing
exchange rate volatility on
trade flows of G-7 countries.
Methodology
The empirical analysis is performed in two parts:
 Assessment of exchange rate changes on
export-price competitiveness of Pakistan’s
manufacturing sector.
 Exchange rate risk analysis for export
competitiveness.
 Empirical methodology followed in this
research is adapted from Abeysinghe and Yeok
(1998) with certain modifications.
Model I –Export Price Competitiveness
ln PX ,t   0  1 ln Pm,t   2 ln UBCt   3 SBRTx, t  ln Px,t (1)
Px,t
Pm,t
SBRTx,t
UBCt
Export price index in year t.
Import price index in year t.
Export subsidies in year t.
Unit business cost in year t.
Modifications


Abeysinghe and Yeok has taken UBC as composite
index of unit labour cost, services cost, and
governmental rates and fees. In this research UBC is
(based on employment cost and cost of electricity
and fuel--Index is made by dividing these costs by
value added in the manufacturing sector).
There are no export subsidies in Abeysinghe model
but in case of Pakistan subsidies are important
determinants of exports. Export subsidies that reflect
the extent to which price paid by foreign importers
of the exportable is reduced (captures the impact of
export promotion policies.)
Model-II: GARCH-M

To investigate volatility in exchange rate, the
GARCH(1,2)-M based on SC criteria model is
used to capture the effects of the exchange rate
through import prices on export-price
competitiveness.

An important application of ARCH and
GARCH models is to measure and forecast the
time varying volatility.
GARCH-M: Mean and Variance
Equation
Mean Equation:
Px ,t  o  1 Pm ,t  21 SBRT x , t
 3UBC t  4 f ( )  U t
2
t
This equation shows the relationship between export-price,
import-price, export subsidies and unit business cost. In
addition, the coefficient φ4 measures the trade-off between
exchange rate risk and export competitiveness, in other
words it explains the needed compensation to exporter for
facing exchange rate risk.
Contd…
Variance Equation:
   O  1
2
t
2
t i
 
2
t i
This equation captures the effect of volatility in export
competitiveness due to exchange rate risk captured by
import-price.
Data
Variables needed for this research are:
 Export price index (Px)
 Import price index (Pm)
 Export Subsidies (SBRTx)
 Unit business cost (UBC)


Annual data used are from 1970-2008.
All time series data are
stationarity using ADF test.
tested
for
Data Sources





Censes of Manufacturing Industries
(CMI)
Statistical Year Book of Federal
Bureau of Statistics (FBS)
International Financial Statistics
(IMF)
CBR Year Book
Economic Survey (various issues)
Estimation Procedure
1- Augmented Dickey Fuller (ADF)–non stationary-Log
first difference.
2- Relationship by estimating multivariate regression
model by Ordinary Least Square (OLS).
3- Exchange rate risk analysis by applying Generalized
Autoregressive Conditional Hetroscedasticity
(GARCH).
Stationarity
The ADF test indicates the acceptance of
the unit root hypothesis at level, that is, the
time series have a unit root.
 The results indicate the first differences of
variables of export price, import price,
export subsidies rate and UBC are on a
stationary process, as the null hypothesis of
unit root is rejected. Hence, these series are
integrated of order 1, i.e., d(1).

Relationship between export-price
competitiveness and its determinants
Variable
Coefficient
t-stat
Import Price (Pm)
0.71*
5.89
Export Subsidies (SBRTx)
0.03
1.36
Unit Business Cost (UBC)
-0.49*
-2.17
Export Price (-1)
0.22**
1.71
2.15
2.09
Constant
Adjusted R2
0.98
Durbin-Watson statistic
1.74
F-statistic
Note: * indicates statistical significance at 1% level.
676.45
** indicates statistical significance at 5% level.
Relationship by OLS
Relationship - estimated by regressing export-price on
import-price, export subsidies and UBC.
 OLS technique is used.
Results show:
 Import prices - positively and significantly associated
with export price competitiveness.
 Subsidies - positively but insignificantly associated with
export competitiveness.
 Unit business cost – negatively and significantly affecting
the export competitiveness.
 Lag of exports- positively and significantly affecting
export competitiveness.
Analysis shows significance of import-price (also
reflecting changes in exchange rate) and UBC on exportprice competitiveness.

Contd…

The relationship between export-price and import-price
is positive because the lower import content in the
production of exportables allows exchange rate
depreciation to significantly impact the export-price
competitiveness. (Overall devaluation of Pak currency
viz a viz US dollar is 7.61 percent in 1972-2008).

In addition to exchange rate changes, productivity
gains
also
contribute
to
enhance
export
competitiveness. (Overall average of TFP growth rate
is 1.81 percent in 1972-2008).
Thus positive changes in domestic value added in the
presence of currency adjustment play an important
role in improving export-price competitiveness.
Export-price competitiveness with GARCH (1, 2)-M
Coefficient
Z-statistic
0.108***
2.073
C
1.480***
1.884
Pm
0.522**
9.366
SBRTx
0.071**
3.894
UBC
-0.365**
-2.182
Export(-1)
0.374**
7.205
0.0014***
0.619
0.804
1.486
GARCH(1)
-0.298***
-1.708
GARCH(2)
0.385***
1.695
Mean Equation:
GARCH-M
Variance Equation:
C
ARCH(1)
Adjusted R-squared
0.98
Note: ** indicates statistical significance at 5%. *** indicates statistical significance at 10%.
GARCH-M






Import Price Index calculated on the basis of domestic currency
captures variability in exchange rate.
GARCH-M term is positive and significant indicating that
exchange rate risk has positive and significant compensation of
risk on export competitiveness.
Variance equation explains how much variance is affected by the
past lag residuals and how much is influenced by past variance.
GARCH (1)
GARCH (2)
significant
significant
The significance of GARCH terms shows previous variance is
significantly contributing to current variance.
Exchange Rate depreciation risk decreases export-price
competitiveness.
Conclusion
Conclusions are:

Exporters react differently to the exchange rate and its
associated risk. Findings reveal that exchange rate risk has
positive and significant compensation, affecting export
competitiveness.

In case of Pakistan we find that the exchange rate risk also
influence export price and the domination of exchange rate
risk leads to a decrease in export competitiveness resulting
into weak export growth.
Policy Recommendations
The analysis of this study leads us to several policy implications:
 Policymakers need to carefully watch movements in import prices
denominated in local currency, and export subsidies. There is a
need to create a synergy between trade policy and exchange rate
policy. Reduction in exchange rate fluctuations and reducing antiexport bias will be desirable policy instruments.

Policy makers may consider prudent foreign exchange market
interventions since exchange rate risk factor do offset positive
effects of depreciation.

The government may take measures to enable exporting firms in
upgrading and meeting international standards by streamlining
technology development. This would enable industries to achieve
high growth in total factor productivity.
Thank You