External Debt and Exchange Rate Volatility in Pakistan: Empirical Analysis and Policy Implications

The main objective of this research paper is to investigate into the association between external debt and exchange rate volatility, utilizing 35 years' time series data spanning over a period from 1985 to 2020. Different analytical techniques such as descriptive statistics, ADF's unit root test, Bound test, ARDL model, and Error Correction Model were employed to determine short run and long run relationship between variables. The exchange rate was dependent variable while independent variables include inflation, interest rate, GDP growth rate, Current account balance, terms of trade and external debt. The empirical analysis reveals negative association between external debt with exchange rate and increasing the volume of external debt increases volatility of exchange rate in Pakistan. Therefore, the study suggests that monetary authorities and fiscal managers should reduce the stock of external debt at sustainable level by boosting tax revenue.