ASYMMETRIC RESPONSE OF DISAGGREGATED IMPORT DEMAND TO EXCHANGE RATE MOVEMENTS: A SMALL OPEN ECONOMY PERSPECTIVE

Abstract

Net importing countries are very susceptible to changes in the value of their currency. Pakistan, being a small open economy, faces a constant pressure in its current account and BOP, which leads to unavoidable stress on its exchange rate. Exchange rate movements affect the cost of imports directly which have been studied extensively in empirical literature. However, these studies ignore the possibility of asymmetric effects of exchange rate and its impact on import demand in Pakistan. An appreciation in exchange rate may have a different impact on demand for imports than depreciations depending upon the level of rigidity in consumer preferences as well as the availability of substitutes for consumer goods, capital goods and raw materials. We use quarterly data of Pakistan’s consumer goods, capital goods and raw material imports from 2005:Q1 to 2018:Q4 and employ a relatively recent econometric methodology, namely, Nonlinear Autoregressive Distributed Lag (NARDL) technique. The results confirm the existence of asymmetric impact of exchange rate in the long-run. The appreciation of currency has more pronounced impact in increasing imports relative to the depreciation of it in decreasing imports. There are further differences of this effect within imports across consumer goods, capital goods and raw materials. We present policy implications of this asymmetric effect of exchange rate on disaggregated consumer imports.