AbstractPakistan’s exchange-rate debate is usually reduced to the rupee–dollar rate. That misses the policy variable that matters for trade: the real effective exchange rate (REER), a trade-weighted measure of the currency adjusted for relative prices. The State Bank of Pakistan’s index rose from 103.99 in January 2026 to 106.44 in June, a 2.35 percent real appreciation. The level, however, is not a direct estimate of misalignment: 100 is the 2010 base-year value, not an equilibrium target. This paper therefore distinguishes movement from misalignment and reads the REER alongside export performance, remittances, energy and logistics costs, private credit, and taxation. It shows that Pakistan’s recent external stability remains heavily supported by remittances and import sensitivity while goods exports weakened in July–March FY2026. The paper also identifies a policy contradiction: goods exports face a 1.25 percent minimum tax on gross proceeds, compared with a 0.50 percent adjustable advance tax on sales to active-taxpayer retailers in a narrow transaction-rate comparison. A competitive REER is necessary, but durable export growth requires tax neutrality, lower system costs, deeper private finance and sustained productivity reform.

Executive summary1. The REER appreciated in the first half of 2026. The SBP index increased from 103.99 in January to 106.44 in June. Under the SBP convention, that is a 2.35 percent real appreciation over five monthly intervals.

2. An index above 100 is not proof of overvaluation. The index is normalized to 2010 = 100. Estimating equilibrium requires a model of the current account, productivity, terms of trade, capital flows and policy distortions. Recent IMF assessments placed Pakistan’s gap near one percent around 2023–24, not eight to eleven percent.

3. External stability is not yet export transformation. In July–March FY2026, goods exports fell 5.8 percent while goods imports rose 7.8 percent. Remittances reached US$30.3 billion and exceeded goods-export receipts; IT exports grew strongly, but the goods base remained narrow.

4. Tax policy works against the export objective. After the 2026 change, section 154 collects 1.25 percent of gross goods-export proceeds as minimum tax. Section 236H collects 0.50 percent on sales to active-taxpayer retailers as adjustable advance tax. The export transaction rate is therefore 2.5 times the local-retailer rate in this specific comparison, although the tax bases and legal character differ.

5. REER management cannot substitute for competitiveness reform. A flexible exchange rate and lower inflation can prevent persistent real appreciation, but export supply also depends on reliable energy, automated refunds, modern logistics, private credit, skills, technology and competition.

1. Introduction: the wrong exchange-rate questionPakistan’s public debate asks whether the rupee is “stable” against the US dollar. Exporters, however, compete against firms in many markets and pay costs set at home. Their relevant price is the real effective exchange rate: a trade-weighted index of the rupee against partner currencies, adjusted for relative inflation. A nominal exchange rate can remain almost unchanged while domestic prices rise faster than those of competitors. In that case, the currency appreciates in real terms and the exporter’s rupee cost base rises relative to foreign rivals.

The distinction matters because Pakistan often treats the exchange rate, subsidies, energy prices, refunds, credit and logistics as separate policy files. Firms experience them as one margin. A real appreciation compresses that margin; a gross-proceeds tax compresses it again; delayed refunds and expensive working capital then turn accounting profit into a cash-flow problem. Trying to support exports while allowing this combined burden to rise is like pouring water into a leaking bucket without fixing the leak.

This paper makes three contributions. First, it corrects the common but misleading claim that a REER index above 100 automatically measures overvaluation. Second, it places the latest REER movement beside the external accounts and structural cost evidence. Third, it integrates the taxation argument into the competitiveness framework using the law as amended through June 2026. The result is a policy diagnosis, not a call for an arbitrary nominal exchange-rate target.

2. Measurement, evidence and limitsThe SBP publishes a monthly consumer-price-based REER for 37 trading partners with 2010 = 100. An increase denotes real appreciation and a decrease real depreciation. The measure is useful for tracking direction and cumulative price pressure, but its normalization creates no presumption that 100 is “fair value.” A base-year index answers how the current real trade-weighted rate compares with 2010; it does not answer what rate is consistent with medium-term fundamentals.

Equilibrium or misalignment must be estimated. IMF external-balance assessments........

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