The Bangladesh Development Studies Vol. XXXII, June 2009, No. 2 Assessing the Existence of the J-Curve Effect in Bangladesh by RABEYA KHATOON * MOHAMMAD MAHBUBUR RAHMAN * This paper estimates the short run and long run impact of depreciation of Taka on trade balance in Bangladesh using cointegration techniques. The results support a positive influence of devaluation on trade balance both in the short and long run. The causal relationship between real exchange rate and trade balance is not robust, while the Granger test suggests a bidirectional causal relationship between devaluation and trade balance. The Sims test does not support the hypothesis that trade balance has influence on real exchange rate. On average, the declining segment of the ‘J-curve effect’ has not been evidenced for Bangladesh. I. INTRODUCTION Bangladesh economy is experiencing deficit in her balance of trade from the very beginning, which is the major source of her current account deficit, too. Import payments are two to three times higher than the export receipts generating an increasing trade deficit with increasing volume of exports and imports. Opening up the economy was initiated with the World Bank- IMF structural adjustment programmes of the 1980s with a belief that devaluation is necessary, if not sufficient, for reducing persistence trade deficit. Accordingly, Taka has been devalued frequently which was translated into real devaluation, though less than proportionately. Finally, the floating exchange rate regime was adopted in 2003. The effectiveness of devaluation in improving trade balance depends on whether the Marshall-Learner condition holds, which states that devaluation will be successful in improving trade balance if the sum of the foreign price elasticity of demand for exports and the home country price elasticity of demand for imports is * The authors are lecturer, Department of Economics, University of Dhaka and Graduate Student, Manchester University, UK respectively. They are grateful to Abdur Razzaque for his comments and suggestions on an earlier draft.