I want to know about the relationship between inflation and exports. What is the effect on exports when inflation increases or decreases?
There are some academic papers dealing with this question (but beyond the specific case of Pakistan)
Note first that inflation is inversely correlated with real exchange rates (as long as nominal exchange rates do not adjust instantaneously to prices).
The following numerical example from Gylafson (1999) illustrates the point.
- Suppose the real exchange rate index $R$ is initially 100 and the inflation rate $p$ is 10% per year, so that $R$ decreases gradually to 100/1.1= 90.9 at the end of the year.
- Suppose, moreover, that the nominal exchange rate adjusts fully to prices with a one-year lag, restoring $R$ to 100 at the beginning of next year. This means that the average value of R over the year is (100 + 90.9)/2=95.45.
- Now suppose inflation increases to 20%, so that R falls to 100/1.2=83.3 at year's end. Then the average value of $R$ over the year is (100 + 83.3)/2=91.67.
- Therefore, the real exchange rate is inversely related to inflation as long as the adjustment of the nominal exchange rate to prices is not instantaneous.
Then, currency overluation may hurt exports.
Gylafson (1999)'s paper is interesting because it relates exports and inlfation to growth. His main conclusion is that, in the period under review (1985-94), high inflation and an abundance of natural resources tended to be associated with low exports and slow growth.