A search for an optimum currency area partners for Pakistan

Abstract

This paper empirically examines the existence of a common trend between the exchange
rates of Pakistan and five regional countries Bangladesh, India, Saudi Arabia, Sri Lanka and the UAE with two of their major trading partners, the United States and Japan as base countries. Results from Johansen co integrating analysis show that the strongest evidence points to the existence of common stochastic trends between the Pakistani rupees on the one hand and the Bangladeshi Taka and the Sri Lankan rupee on the other hand. There is no strong evidence for the existence of such a common stochastic trend between the Pakistani rupee and the currencies of India and the Gulf economies. Optimum Currency Area (OCA) theory seems to justify the formation of a currency union between Pakistan,Bangladesh and Sri Lanka. The case of a currency union between Bangladesh and Pakistan is strengthened by a shared political past and a shared history of financial institutional development. The immediate impact of the formation of a currency union on Pakistan’s GDP growth will however be insignificant.

A search for an optimum currency area partners for Pakistan