The relationship between exchange rate fluctuations and economic growth has long been a subject of debate in macroeconomic theory. For emerging economies like Pakistan, where exchange rate policies play a crucial role in economic stability, real exchange rate (RER) misalignments can significantly impact growth trajectories. RER misalignment, which occurs when the actual exchange rate deviates from its equilibrium level, can have both positive and negative effects on economic growth, depending on the direction and magnitude of the misalignment.

In recent years, Pakistan has experienced periods of substantial exchange rate volatility, driven by external shocks, domestic macroeconomic imbalances, and policy adjustments. Such fluctuations raise important questions about the extent to which exchange rate misalignments affect economic growth, and whether these effects are symmetric or asymmetric. Understanding whether there is a threshold level beyond which misalignments start exerting significant growth impacts is essential for policymakers to design effective exchange rate interventions and maintain macroeconomic stability.

This study aims to fill the gap in the existing literature by investigating whether real exchange rate misalignments have threshold effects on economic growth in Pakistan. Using a nonlinear autoregressive distributed lag (NARDL) model, we examine the asymmetric relationship between RER misalignments and economic growth, considering both positive and negative deviations from the equilibrium rate. By identifying potential threshold levels using the Hansen'(2000) threshold regression analysis, the study provides novel insights into how misalignments can influence Pakistan’s economic performance and offers evidence-based policy recommendations to mitigate adverse effects.

The empirical findings of our study suggest that the undervaluation of the Pakistani rupee (PKR) promotes economic growth up to an estimated threshold of a 10.025% deviation from ERER is reached. In contrast, an overvalued Pakistani rupee can stimulate economic growth up to a 9.346% threshold. The study implies that Pakistan should avoid both overvaluation and undervaluation beyond these identified thresholds to sustainably enhance economic growth. Additionally, it recommends that appropriate fiscal and monetary policies be pursued to maintain the exchange rate close to the equilibrium rate.