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Abstract
Fluctuations in exchange rate have threatened the stability of global financial system and have invited unwarranted currency war. South Asia has been experiencing a whopping trade deficit from the last many years. This study is an attempt to analyze the impact of exchange rate depreciation on trade balance by estimating Marshall-Lerner condition for South Asian countries. This study used the panel data of seven South Asian countries consisting of Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan and Sri-Lanka for the period of 1993 to 2010. The study used random effects model (REM) to estimate the import and export demand elasticity. The study used Hausman Specification test to make a choice between fixed effects model and random effects model. The study has also used Breusch-Pagan test to make a choice between random effect model and simple panel ordinary least square model. The study finds that sum of import and export demand elasticity is less than one for South Asian countries, M-L condition does not fulfill, and that is why no improvement in trade balance has been seen in response to exchange rate depreciation. Moreover, the results suggest that some relevant policies like, export promotion measures and industrialization of import substitution must be taken into consideration to improve the trade balance. The study also suggested some future research directions at the end.
Keywords: Marshall-Lerner condition, exchange rate, trade balance, export and import demand elasticity, random effect model, south Asia.
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1.Introduction
A major macroeconomic policy action for a country facing deficit in her trade balance is said to be devaluation of its currency. Exchange rate policy is considered a powerful tool for the regulation of the external sector of the economy. Most of the developing countries face deficit in their trade balances which further cause the balance of payment problem for these countries. Exchange rate policy and deficit in the trade balance have always been a continuous problem for developing economies. Most of the developing countries are facing deficit in their trade balance. These countries devalued their currencies many times with an aim to improve their trade balance. But question arises here is that, whether decrease in exchange rate of a country increases its balance of trade or not? To respond this...