Real Exchange Rate Misalignment and Growth Dynamics: Evidence from Low-Income Developing Economies

Abstract

Most empirical research on real exchange rate misalignment and economic growth adopted a symmetric method, under the assumption that overvaluation and undervaluation have the same effects on economic growth. But recent studies show possible asymmetric impacts of exchange rate misalignments on economic growth. This study, therefore, investigates the asymmetric impact of real exchange rate misalignment on economic growth for ten lower-middle-income economies (LMIEs) (Bolivia, Cameroon, Ghana, India, Morocco, Pakistan, the Philippines, Nepal, Sri Lanka, and Vietnam) between 1990 and 2023. The results reveal significant differences across countries concerning the impact of misalignment on economic growth, in case of both the  linear and nonlinear ARDL models. The findings from the NARDL show that the impacts of undervaluation and overvaluation on economic growth are asymmetric and specific to the country. The results suggest that overvaluation has a positive and significant long-run impact on growth in Cameroon, India, Pakistan, Nepal and Vietnam, but undervaluation has a significant negative impact in the Philippines, Nepal and Sri Lanka. The results contradict the traditional notion that the undervaluing of currencies always stimulates economic growth in lower-middle income economies. Accordingly, the study suggests the formulation of exchange rate policies based on country specific structural conditions – export structure, import dependency, productivity and financial development – instead of a common formula for exchange rate competitiveness.