The impact of exchange rate misalignments on manufacturing investment in Brazil

Abstract

We analyze the hypothesis that variations on manufacturing investment are influenced by the difference between the real effective and industrial equilibrium exchange rates and by the difference between the current account and industrial equilibrium exchange rates (a proxy for the Dutch disease). The current account equilibrium exchange rate is defined as the rate that guarantees that the current account of a country is balanced intertemporally, and the industrial equilibrium exchange rate corresponds to the rate that makes competitive those companies producing internationally tradable non-commodities goods and services in the so-called state-of-art. First, the concepts and methodologies for estimating the current account and industrial equilibrium exchange rate are explained. Then, to test our hypothesis, a database for 24 Brazilian manufacturing sectors was built from 2007 to 2017. A dynamic panel data model was adopted to estimate the relationship between these currency misalignments and the manufacturing investment. The results suggest that the magnitude of those differences influences investment decisions, potentially contributing to economic growth and development.

How important is the real exchange rate for exports and growth?

“…11. Other studies have found positive effects of RER undervaluation specifically on manufacturing investment (for example, Ibarra (2018) for Mexico and Marconi et al (2022) for Brazil), and one study has found a positive effect on manufacturing output (Nalín/Moreno-Brid 2022). These results suggest that RER depreciation can influence structural change in favor of the manufacturing sector, which can contribute to long-run growth.…”