Is It Feasible for Pakistan to Use Domestic Currency for International Settlements

Abstract

The main objective of this study is to analyze four different currencies-based exchange rates by considering major trading partners of Pakistan and evaluate whether Pakistani Rupee (PKR) as a potential candidate for international settlement remain more stable or not. Since the exchange rate instability and large depreciation in terms of United States Dollar (USD) has instigated the policy makers to explore the ways to reduce the dependence over USD for all kinds of international settlement. This study has analyzed more than fifty years monthly data ranging from January 1970 to December 2023 considering four currencies USD, PKR, CHY (Chinese Youan) and SDR (Special Drawing Rights) based exchange rates. Initially GARCH(1,1) models are applied to measure the exchange rate risk and instability than panel data fixed effect models are estimated to evaluate various models including exchange rate volatility, trade balance, export and imports functions, international liquidity and international reserves. The main findings of this study appear to affirm our objective that it is beneficial for Pakistan to trade with major trade-partners in their respective domestic currency and ensure long term exchange rate stability with low risk. Comparatively Chinese Yuan may be more suitable if vehicle currency is indispensable especially in case if target is to accumulate both the international reserves and international liquidity. Consequently, the policy maker should design those policies that may encourage the scope of domestic currency use at least when Pakistan is trading with major trade-partners.