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Large devaluations, foreign direct investment and exports : a speculative note
 
Author:Lederman, Daniel; Collection Title:Policy Research working paper ; no. WPS 5619
Country:World; Date Stored:2011/03/31
Document Date:2011/03/01Document Type:Policy Research Working Paper
SubTopics:Foreign Direct Investment; Economic Theory & Research; Emerging Markets; Currencies and Exchange Rates; Debt MarketsLanguage:English
Major Sector:Industry and tradeRel. Proj ID:1W-Trade Quality -- -- P113810;
Region:The World RegionReport Number:WPS5619
Sub Sectors:General industry and trade sectorVolume No:1 of 1

Summary: One side-effect of the Global Financial Crisis of 2008-09 was the resurgence of a debate over exchange rates. The conventional wisdom dictates that real-exchange rate adjustments are needed in order to bring about changes in trade balances across countries. However, the literature on the effect of exchange rate fluctuations and currency under-valuations on exports is surprisingly ambiguous. This note explores for the first time the potential role of foreign direct investment as an intermediate variable in the process of trade adjustment after large real-exchange rate changes. Real-exchange rate devaluations might result in increases in foreign direct investment inflows, as investors can take advantage of changes in the foreign-currency value of domestic assets. If so, the response of exports will depend to some extent on the nature of such foreign direct investment inflows, with inflows motivated by "horizontal" foreign direct investment associated with negligible changes in export growth after devaluation. The author utilizes quarterly data on real effective exchange rates, foreign direct investment inflows and exports to explore the effects of large devaluations (defined as the largest observed quarterly real effective exchange rate devaluation) on foreign direct investment and exports from 1990 to 2010. The admittedly speculative evidence suggests that there were heterogeneous experiences regarding the timing and magnitude of subsequent changes in foreign direct investment and exports, but on average foreign direct investment inflows tended to precede export surges within two year horizons.

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