A Comparative Analysis of the Effectiveness of Precautionary and Mercantilist Approaches to Accumulation of Foreign Exchange Reserves in Pakistan
DOI:
https://doi.org/10.15678/AOC.2021.2402Keywords:
foreign exchange reserves, foreign debt, international monetary fund, State Bank of PakistanAbstract
Objective: This study explores and compares short-run and long-run analyses of the validity of precautionary and mercantilist approaches to accumulation of foreign exchange reserves (FER) in Pakistan.
Research Design & Methods: This study uses quarterly data from 1990 (1st) to 2015 (4th). The autoregressive distributed lags (ARDL) test is used to check short-run and long-run analyses of the mercantilist and precautionary approaches for the accumulation of foreign exchange reserves in Pakistan.
Findings: The empirical results of the study reveal that Pakistan accumulates FER for a precautionary motive. The variables associated with precautionary motives are economically and statistically important in explaining FER accumulation. In contrast, variables linked to mercantilist motives are statistically significant, while insignificant economically for FER accumulation.
Implications / Recommendations: In an underdeveloped economy like Pakistan’s, a large volume of international reserves helps not only in handling exchange rate strategies, but also in pursuing macroeconomic policies such as: export promotion, development projects, repayment of foreign debt, maintaining employment opportunities, and improvement of the financial sector.
Contribution: The econometric estimates show that Pakistan accumulates FER for a precautionary motive. The variables associated with precautionary motives are economically and statistically important in explaining FER accumulation. In contrast, variables linked to mercantilist motives are statistically significant, while insignificant economically for FER accumulation. These results are also true for most of the research studies, including on China, that we see in the literature.
References
Aizenman, J. and Lee, J. (2007) “International Reserves: Precautionary versus Mercantilist Views, Theory and Evidence”. Open Economies Review 18: 191–214, https://doi.org/10.1007/s11079-007-9030-z.
Aizenman, J. and Marion, N. (2004) “International Reserve Holdings with Sovereign Risk and Costly Tax Collection”. The Economic Journal 114(497): 569–91, https://doi.org/10.1111/j.1468-0297.2004.00232.x.
Akdoğan, K. (2010) “Foreign Exchange Reserve Demand: An Information Value Approach”. Central Bank Review 10(2): 33–44.
Chaudhry, I. S., Akhtar, M. H., Mahmood, K. and Faridi, M. Z. (2011) “Foreign Exchange Reserves and Inflation in Pakistan: Evidence from ARDL Modelling Approach”. International Journal of Economics and Finance 3(1): 69–76, https://doi.org/10.5539/ijef.v3n1p69.
Cruz, M. (2015) “The Need for Official Reserves in Latin America: Assessing the Precautionary Motive, 1995–2011”. Cuadernos de Economía 34(65): 327– 47, https://doi.org/10.15446/cuad.econ.v34n65.42611.
Davidson, R. and MacKinnon, J. G. (1981) “Several Tests for Model Specification in the Presence of Alternative Hypotheses”. Econometrica: Journal of the Econometric Society 49(3): 781–93, https://doi.org/10.2307/1911522.
Dooley, M. P., Folkerts-Landau, D. and Garber, P. M. (2003) “An Essay on the Revived Bretton Woods System”. National Bureau of Economic Research Cambridge. Mass., USA.
Edwards, B. and McCarthy, J. D. (2004) “Resources and Social Movement Mobilization” in: D. A. Snow, S. A. Soule, H. Kriesi (eds), The Blackwell Companion to Social Movements, 116 –52. Malden: Blackwell Publishing.
Friedman, M. and Friedman, M. (1953) Essays in Positive Economics. University of Chicago Press.
Heller, H. R. (1966) “Optimal International Reserves”. The Economic Journal 76: 296–311, https://doi.org/10.2307/2229716.
Kemal, A. (2002) “Optimal Level of Reserves in Developing Economies with Special Reference to Pakistan”. Public Policy Papers 1.
Kenen, P. B. and Voivodas, C. S. (1972) “Export Instability and Economic Growth”. Kyklos 25(4): 791–804, https://doi.org/10.1111/j.1467-6435.1972.tb01082.x.
Khan, K., Ahmed, E. and Kazmi, A. A. (2005) “The Demand for International Reserves: A Case Study of Pakistan [with Comments]”. The Pakistan Development Review 44(4II): 939–57, https://doi.org/10.30541/v44i4iipp.939-957.
Prabheesh, K., Malathy, D. and Madhumathi, R. (2009) “Precautionary and Mercantilist Approaches to Demand for International Reserves: An Empirical Investigation in the Indian Context”. Macroeconomics and Finance in Emerging Market Economies 2(2): 279–91, https://doi.org/10.1080/17520840902726367.
Ramachandran, M. (2004) “The Optimal Level of International Reserves: Evidence for India”. Economics Letters 83(3): 365–70, https://doi.org/10.1016/j.econlet.2003.11.015.
Tariq, M., Haq, Z., Kakakhel S. J., Jehangir, M. and Aamir, M. (2014) “Real Exchange Rate and Foreign Exchange Reserves: A Mercantilist View”. Life Science Journal 11: 13–25.
