Exchange rate has proved its behavior in determining the country economic position in this age of globalization and trade liberalization. Therefore, this research investigates that the determinants of trade i.e. Import, export, industrial growth, consumption level and oil prices fluctuation brings changes in exchange rate and its influence eventually on balance of payments in comparison of Indian and Pakistani economies. Data of defined variables is collected on annual basis of India and Pakistan for thirty one years. By applying cointegration, it is estimated that there exist a long run relationship in both countries. India and Pakistan has significantly and correctly sign the short run dynamic and some of the factors have not. In Pakistan balance of payment does granger cause exchange rate. For India, exchange rate does not granger cause balance of payment. It is concluded that exchange rate is very important determinant of trading in an open economy. Dealing in foreign exchange market, currency change affects every economy including developed or developing. This occurs because of the market forces of supply and demand, which pushes countries exchange rate as depreciated and appreciated.
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