Unravelling the nexus between exchange rate undervaluation and global value chains participation

Undervaluation of the real exchange rate (RER) can influence exports performance, but also country’s participation in global value chains (GVCs). Yet, in GVCs, where products become multi-country products as intermediate inputs are imported, transformed, and then re-exported, GVC-related trade is expected to respond differently to exchange rate undervaluation compared to traditional trade in single-country goods. Thus, using the EORA dataset for 143 countries over the period 1995–2018, we assess the impact of this policy on a country’s backward and forward participation in value chains, with a special focus on two moderating factors, namely the quality of institutions and digitalization. Our results show that currency undervaluation displays a positive impact on these two ways of participating in GVCs. Consistent with what has been noted in a recent strand of literature, undervaluation acts as a compensatory factor for countries with weak institutions, and the impact of this undervaluation becomes more pronounced as the level of digitalization in the economy increases. These results remain robust to a battery of robustness checks.