The study adopts a multilateral framework to analyze REER behavior and its interaction with export performance, inflation differentials, capital flows, and industrial profitability. Pakistan’s historic experience shows that sustained real overvaluation has generally weakened exports, while periods of real adjustment have tended to support competitiveness. This perspective is particularly relevant in an environment where exchange-rate dynamics are influenced not only by trade flows but also by external financing, reserve accumulation, and policy credibility.

Recent exchange-rate stability has been underpinned by IMF-anchored inflows, bilateral rollovers, strong remittance growth, and improved foreign-exchange market functioning. These factors have helped contain volatility and anchor expectations even as import demand recovered. At the same time, higher domestic inflation relative to trading partners has kept the real exchange rate mildly elevated, indicating that nominal stability has not translated into a corresponding improvement in external competitiveness.

The study situates these trends within Pakistan’s broader macroeconomic context, in which exchange-rate outcomes reflect persistent trade-offs between inflation control, growth, and competitiveness. While reserve accumulation has strengthened short-term buffers and reduced near-term volatility, structural trade imbalances and continued reliance on external financing continue to shape the real exchange rate. Experience suggests that delaying real adjustment increases the risk of abrupt and disruptive corrections.

Overall, the study underscores the importance of distinguishing between nominal exchange-rate stability and real competitiveness when assessing Pakistan’s external position. By focusing on REER dynamics, it provides a clearer framework for understanding how inflation differentials and external inflows influence trade performance and external sustainability over time.

Expert Input and Policy Recommendations

These recommendations, informed by expert input from a prominent Pakistani economist and a former Governor of the State Bank of Pakistan, supported by secondary research, emphasize that exchange-rate management must be complemented by stronger fiscal transparency, reduced reliance on debt-driven inflows, and structural reforms to improve export competitiveness.

Maintain a Market-Based Exchange Rate with Gradual Adjustment

• Support a managed-float regime where market forces determine direction while the SBP smooths excessive volatility.
• A gradual, market-aligned depreciation path should reflect underlying conditions, shifting policy focus toward export-led foreign exchange generation.

Strengthen Transparency of External Liabilities and Fiscal Risks

• Pakistan’s cash-based accounting framework obscures liabilities from SOEs and government guarantees not fully reflected in official figures. Recognizing and consolidating these liabilities is critical for realistic REER assessment and external sustainability analysis.

Adopt a Broader Framework Beyond REER for Policy Assessment

• REER should not be used as a standalone indicator; structural distortions limit its ability to reflect the true equilibrium exchange rate.
• Structural reforms in energy pricing, taxation, logistics, and productivity are essential to support export growth.

Rationalize Domestic Cost Structures to Support Exports

• Higher tariffs on industry raise production costs, offsetting gains from exchange-rate adjustment.
• Reforming subsidy structures, particularly for domestic consumers, addresses cross-subsidization and improves competitiveness more sustainably than depreciation alone.

Allow Exchange Rate Adjustment to Reflect Underlying Fundamentals

• A moderate exchange-rate adjustment (around 5-10%) may be required to align the currency with underlying fundamentals.

Strengthen Trade Facilitation and Global Value Chain Integration

• Competitiveness depends on logistics, cost efficiency, and trade facilitation, not just exchange-rate levels.
• Policy should enable firms to integrate into international production networks and diversify export markets.

Improve Data Transparency and Institutional Capacity

• Ministries lack accurate data on external obligations, with some relying on external agencies for verification.
• Strengthening data systems is essential for credible macroeconomic and exchange-rate policy.

Transition to Accrual-Based Fiscal Accounting

• Shifting from cash-based to accrual accounting will ensure liabilities, including guarantees, are recorded when incurred rather than when paid.
• This will improve decisions related to debt sustainability and exchange-rate management.

The PBC is a private sector not-for-profit advocacy platform set-up in 2005 by 14 (now 100+) of Pakistan’s largest businesses. PBC’s research-based advocacy supports measures which improve Pakistani industry’s regional and global competitiveness. More information about the PBC, its members, objectives and activities can be found on its website: www.pbc.org.pk

Historically, Pakistan has attracted market-seeking FDI, primarily aimed at serving its domestic consumer base. Though multinational companies in Pakistan have been raising tax revenues through a high level of compliance and contributing to improved labor productivity by bringing global best practices to their supply chain – which are replicated by the industry in general – they do not export from Pakistan as exports are not the primary purpose of their presence in the country despite their global marketing networks. Due to protection through higher import tariffs on finished goods (than on imported intermediates), they can compete locally but not globally. High energy costs don’t help. Hence, none of the MNCs have meaningful exports.

This domestic market focus has led to short-term gains, particularly in sectors like telecommunications and power, but has not resulted in sustained, broad-based economic growth. Significant FDI inflows have been offset by large outflows, as foreign investors repatriate profits, dividends, and royalties, draining Pakistan’s foreign reserves and limiting reinvestment in the local market.

The paper highlights the limitations of market-seeking FDI, noting that while it initially brings in capital, it often fails to deliver long-term development benefits. Instead, it argues for a shift toward efficiency-seeking FDI, driven by labor market competitiveness, focused on the country’s comparative advantage, and addresses the scope for improved market access (particularly China, Central Asia and other partner countries with whom Pakistan has market access agreements such as the EU, Türkiye, etc. ,). FDI should ideally focus on export-oriented as well as import-substitution industries and in those sectors for which local investors lack knowledge or access to foreign capital. Examples of the latter are mining, petrochemicals, etc. Such investments, aimed at leveraging Pakistan’s lower labor costs, natural resources and large domestic market, would not only integrate the country into global value chains but also create positive spillovers for domestic industries by boosting innovation and productivity.

In conclusion, the paper calls for a recalibrated approach to FDI. It advocates for targeted policy reforms that attract efficiency-seeking FDI and foster export-led growth rather than relying solely on investments that cater primarily to local demand. It emphasizes the need for Pakistan to break away from the “all FDI is good” mindset. Barring rare exceptions, future FDI should be directed to investments that can positively impact the external account within a reasonable period of time.