Pakistan is associated with high political instability and is highly indebted country: which exchange rate regime should

Pakistan be adopting? Place your argument in favor or against the floating exchange rate system.
Exchange Rate is the rate at which domestic currency is exchanged with other currencies in foreign exchange market. An exchange rate is the current market price for which one currency can be exchanged for another.

Types Of Exchange Rate System;

Fixed Exchange Rate System: In fixed exchange rate system government sets the external value of currency and keep it fixed by sale and purchase of foreign reserves against domestic currency Managed Floating Exchange Rate System : It is an exchange rate system in which the external value of currency is determined by the forces of demand and supply within certain limits known as bands. When the exchange rate cross either of the limit, the government intervenes and bring it back with the limits through buying and/or selling the foreign reserves. Free Floating Exchange Rate System : In such exchange rate system the external value of the currency is determined by the interaction of demand and supply in foreign exchange market.

Brief Back Ground Of Pakistans Exchange Rate:

Over the past 50 years, Pakistans exchange rate regime is aimed at becoming deregulated and market-oriented.Prior to 1970s,Pakistan tied its currency, rupee ,in terms of Pound Sterling.In 1971, with the evident emergence of USA economy, Pakistan switched its currency to be in terms s of U.S. Dollars.A budget deficit in 1982 influenced Pakistan to opt for controlled floating exchange rate.From 1999-2007 Rs value remained stable at $1=PKR 60.During 2008, price of $1 reached to a maximum of PKR 86.7 due to political instability and elevated oil prices

Analysis:
Given the current condition of Pakistan with high political instability and indebted I would recommend that Pakistan should pursue Fixed/pegged Exchange Rate System. A pegged
exchange rate system is a type of fixed exchange rate system . Typically, a country will "peg" its currency to a major currency such as the U.S. dollar, or to a basket of currencies. The choice of the currency (or basket of currencies) is affected by the currencies in which the country's external debt is denominated and the extent to which the country's trade is concentrated with particular trading partners. The case for pegging to a single currency is made stronger if the peg is to the currency of a principal trading partner. If much of the country's debt is denominated in other currencies, the choice of which currency to peg it to becomes more complicated.

I have recommended fixed exchange rate regime because Pakistan is a country with a lot of certainty and confidence issues, determining a fixed exchange rate will put all the ,uncertainties prevailing in both within and outside Pakistan, to a halt.This will create a room for long term investments as investors will be confident as businesses have the perfect knowledge that the
price is fixed and therefore not going to change they can plan ahead in their productions. Speculations regarding the exchange rate can/will also be eliminated which will abandon activities such as hording and black marketing which will increase the production of the country and thus will lead to economic development. As Pakistan is very much politically instable, keeping a fixed exchange rate will not let political activities come in the way of international trading which might wouldnt have been the case if Pakistan had chosen Flexible exchange rate because then any political instability would have caused a fall in demand of domestic currency and thus an uncertainty of Pakistani currency. Dealing with fixed exchange rate will lead t a promotion of international trade as Fixed or

stable exchange rates ensure certainty about the foreign payments and inspire confidence among the importers and exporters. Thus helps to promote international trade.

Fixed exchange rate will also reduce the uncertainty among the government and hence the government will be able to plan a smooth and long term development programs which will lead to a systematic and continuous economic growth of the country. Inflation will also be kept low as inflation tends to effect the exchange rate by effecting the price of imports and exports thus to maintain a stable exchange rate the government will be forced to keep the inflation low and at a steady rate. Fixed exchange rate will help to improve the balance of trade as Pakistan will have a choice of keeping a low exchange rate.This will make exports more price competitive in international market and will make imports expensive thus exports will be greater than imports. This will intern makes inflow of money greater than outflows and thus improving the balance of payment. Pakistan is a developing country and therefore is in constant need of importing machinery and technology from developed countries. As Pakistan will have a power to fluctuate its exchange rate it can keep an appreciated exchange rate which will make import of technology cheaper. Another advantage of keeping a high exchange rate is that Pakistan will be able to pay off its debt at a cheaper real value.

Conclusion:
As a result of all the above mentioned advantages and strategies Pakistan will have an opportunity to become economically stale despite of being indebted and politically instable and hence grow at a much faster rate than it would have if it was operating under Flexible exchange rate.

References:
http://wiki.answers.com/Q/What_are_the_advantages_and_disadvantages_of_both_a_fixed_exchange _rate_regime_and_a_flexible_exchange_rate_regime http://www.preservearticles.com/201012291897/advantages-disadvantages-fixed-exchange-rates.html http://www.investopedia.com/exam-guide/cfa-level-1/global-economic-analysis/fixed-peggedexchange.asp#axzz1mCS5DuSa