## Real Exchange Rates, Economic Complexity, and Investment — Section 1 (WP/18/107)

## Source details

**Canonical URL:** [Real Exchange Rates, Economic Complexity, and Investment — Section 1 (WP/18/107)](https://www.imf.org/-/media/files/publications/wp/2018/wp18107.pdf)

## Other formats

- [Markdown version](/-/media/files/publications/wp/2018/wp18107.pdf.md)
- [Structured JSON version](/-/media/files/publications/wp/2018/wp18107.pdf.json)

---

### Abstract and main empirical finding
- Firms in advanced economies and in emerging Asia increase investment when the domestic currency weakens, consistent with the Mundell-Fleming model.
- In other emerging market and developing economies, and in some advanced economies with a low degree of structural economic complexity, corporate investment increases when the domestic currency strengthens—consistent with Diaz Alejandro (1963) because capital goods are mostly imported and a stronger real exchange rate reduces firms’ investment costs.
- The degree of economic complexity helps reconcile these opposing effects:
  - In more complex economies (generally advanced economies and emerging Asia) the competitiveness channel of a real depreciation tends to dominate.
  - In less complex economies the imported-capital-cost channel tends to dominate.
- Using a simple measure of real exchange rate misalignment, most results carry through, except advanced economies that are less complex behave like non-Asian emerging markets: corporate investment increases when their currencies are overvalued.

### Theoretical framework (augmented Q-model of investment)
- Setup:
  - Firms produce tradable goods and purchase tradable investment goods (capital purchased abroad).
  - Objective: maximize discounted flow of dividends, D_t, with exogenous gross interest rate R.
  - Real exchange rate e: an increase denotes a real depreciation.
- Key model elements and equations (as presented):
  - Dividend flow: D_t = π(K_t, θ_t, e_t) − e_t I_t − c(I_t, K_t).
  - Capital accumulation: K_{t+1} = I_t + (1−δ) K_t.
  - First-order condition leading to Tobin’s q: e_t + c_I(I_t,K_t) = (1/R) E_t[q_{t+1}].
  - With adjustment cost c(I_t,K_t) = (1/2) b (I_t/K_t − μ)^2 K_t, investment equation:
    - I_t/K_t = (1/(bR)) E_t[q_{t+1}] − e_t/b + μ.
  - Comparative-static on real exchange rate (equation (14)): ∂I_t/∂e_t shows two opposing forces:
    - Competitiveness channel: higher e (real depreciation) raises continuation value V_k, stimulating investment if V_{k e} − π_{K e} > 0.
    - Imported-capital-cost channel: higher e raises domestic cost of imported capital goods, reducing investment.
  - Net sign depends on relative strength of channels; degree of economic complexity expected to influence elasticities.

### Empirical strategy and data
- Rationale for firm-level analysis:
  - REER movements are exogenous to individual firms, reducing reverse causality present in aggregate analysis.
  - Firm-level approach mitigates endogeneity tied to aggregate current account adjustments and avoids problems related to investment deflators affected by REER movements.
- Data:
  - Unbalanced panel of 40,412 firms from 71 economies for the period 1995—2016 (annual frequency).
  - Firm-level source: Thomson Reuters Worldscope.
  - Country REER data: IMF’s International Financial Statistics.
  - Global VIX: Bloomberg, L.P.
- Sample cleaning and truncation:
  - Observations with inconsistent data dropped (negative values of total assets; capital expenditure; property, plant, and equipment; common equity; total debt; interest expenses; and depreciations).
  - Firm-level observations truncated below the 1st percentile and above the 99th percentile to avoid outliers.
  - For the investment ratio, leverage, and interest expense ratio truncation was applied only for observations higher than the 99th percentile because the 1st percentile value was zero.
- Coverage by firm type and industry:
  - Sample excludes financial firms (finance, insurance, real estate, public administration).
  - Manufacturing: close to 52 percent of observations in the total sample.
  - Services: 14 percent.
  - Transportation, communications, and utilities: almost 10 percent.

### Empirical approach
- Estimation method: diff-in-diff firm-level panel OLS with firm fixed effects; robust standard errors clustered by country.
- Baseline regression (dependent variable ICR_{j,c,t}) includes:
  - Lagged ICR (ICR_{j,c,t-1}), country-level Real Effective Exchange Rate growth (REER_gr_{c,t}), firm-level controls X_{j,t} (Tobin’s q, cash flow, leverage, change in debt, sales growth), lagged VIX, and year, industry-year, and country-year fixed effects.
- Interpretation of coefficient γ on REER_gr:
  - γ < 0: firm-level investment increases when the domestic currency weakens in real terms.
  - γ > 0: firm-level investment increases when the domestic currency strengthens in real terms.
- Alternative specification: replace REER growth with REER_Mis (real exchange rate misalignment).

### Key summary statistics (sample-level)
- Full sample: 40,412 firms / 348,149 observations.
- ICR: Mean 0.27; Median 0.15; Std. Dev. 0.43; Min 0.006; Max 6.41.
- Tobin’s Q: Mean 1.46; Median 1.13; Std. Dev. 1.08; Min 0.29; Max 12.51.
- Cash flow: Mean 0.25; Median 0.22; Std. Dev. 2.65; Min -61.60; Max 20.00.
- Leverage: Mean 0.89; Median 0.50; Std. Dev. 1.27; Min 0.00; Max 12.70.
- Interest expense ratio: Mean 0.09; Median 0.05; Std. Dev. 0.17; Min 0.00; Max 2.61.
- Change in debt: Mean 0.25; Median 0.01; Std. Dev. 1.53; Min -6.31; Max 19.95.
- Sales growth: Mean 0.14; Median 0.07; Std. Dev. 0.46; Min -0.87; Max 6.17.
- Real Effective Exchange Rate Growth: Mean 0.38; Median 0.43; Std. Dev. 6.29; Min -74.07; Max 135.49.
- Real Effective Exchange Rate Misalignment: Mean -0.99; Median -1.04; Std. Dev. 12.47; Min -51.50; Max 371.19.
- Cboe Volatility Index (VIX): Mean 20.69; Median 22.07; Std. Dev. 6.07; Min 12.77; Max 32.55.
- Regional sample sizes:
  - Emerging and Developing Economies: 100,171 obs.
  - Advanced Economies: 247,978 obs.
- Top-five country shares in the database: United States 19.1 percent; Japan 10.9 percent; China 7 percent; India 5.7 percent; United Kingdom 5 percent.

### Main empirical results — REER growth and REER misalignment (regional heterogeneity)
- Selected coefficients on REER_gr (Table 3, reported estimates):
  - Advanced (Col 1): REER_gr = -0.0053*** (s.e. 0.0003)
  - Emerging and Developing (Col 2): REER_gr = 0.0010 (not significant; s.e. 0.0828)
  - Developing Asia (Col 3): REER_gr = -0.0010*** (s.e. 0.0002)
  - Developing Europe (Col 4): REER_gr = 0.0049*** (s.e. 0.0013)
  - LAC (Col 5): REER_gr = 0.0005*** (s.e. 0.0001)
  - MENA (Col 6): REER_gr = 0.0274*** (s.e. 0.0026)
  - SSA (Col 7): REER_gr = 0.0080** (s.e. 0.0013)
- Interpretation:
  - Firms in advanced economies and in developing Asia increase investment when the domestic currency weakens (negative coefficients).
  - For several emerging market regions (developing Europe, LAC, MENA, SSA) the coefficient is positive—firms invest more when the domestic currency strengthens.
- Selected coefficients on REER_Mis (Table 4, reported estimates):
  - Advanced (Col 1): REER_Mis = -0.0021*** (s.e. 0.0003)
  - Emerging and Developing (Col 2): REER_Mis = 0.0008 (s.e. 1.1125)
  - Developing Asia (Col 3): REER_Mis = -0.0018*** (s.e. 0.0001)
  - Developing Europe (Col 4): REER_Mis = -0.0052*** (s.e. 0.0007)
  - LAC (Col 5): REER_Mis = 0.0007*** (s.e. 0.0001)
  - MENA (Col 6): REER_Mis = 0.0134*** (s.e. 0.0013)
  - SSA (Col 7): REER_Mis = 0.0088*** (s.e. 0.0008)
- Economic magnitude:
  - A one-standard-deviation shock to the measure of real exchange rate misalignment shifts the investment-capital ratio by about 3-4 percentage points across regions.
  - Given sample ICR medians near 15 percent for both advanced and emerging economies, this is a non-trivial impact on investment.
- Plausible mechanism for positive coefficients in many emerging regions:
  - Dependence on imported capital goods: currency strengthening (overvaluation) makes imported capital goods cheaper, facilitating investment.
  - Production structure and economic complexity affect whether competitiveness (weak currency) or cheaper imported inputs (strong currency) dominates.

### Role of economic complexity (ECI)
- ECI used as proxy for knowledge intensity, diversification, and production capability.
- Regional patterns:
  - Advanced economies and developing Europe have higher ECI; Sub-Sahara Africa the lowest.
  - Developing Asia shows the highest increase in complexity since 1995 (index presented both standardized 0–1 and 1995=100 series).
- Quartile analysis (Tables 5 and 6):
  - Countries in the lower quartile of ECI (less complex economies): coefficient on REER growth is positive — firm-level investment increases when domestic currency strengthens.
  - Countries in the upper quartile of ECI (mostly advanced economies): coefficient on REER growth is negative — real depreciation is associated with higher firm-level investment.
  - Replacing REER growth with REER misalignment yields similar patterns, with the note that less complex advanced economies behave like emerging markets: corporate investment increases with overvaluation.
- Table 6 (selected estimates, All Countries, column 4, first panel):
  - ICR (t-1): 0.0701*** (0.0085)
  - Tobin’s Q: 0.0427*** (0.0043)
  - Leverage (t-1): -0.0203*** (0.0018)
  - Change in debt: 0.0455*** (0.0058)
  - Sales growth (t-1): 0.0003*** (0.0001)
  - REER Growth: 0.0071*** (0.0009)
  - REER Growth X Economic Complexity Index: -0.0084*** (0.0014)
  - VIX (t-1): -0.0193*** (0.0040)
  - Observations: 328,168; R-squared: 0.0869; Number of firms: 39,551; Number of countries: 76.
- Table 6 (alternative specification with REER Misalignment, All Countries, second panel, column 4):
  - ICR (t-1): 0.0755*** (0.0110)
  - Tobin’s Q: 0.0438*** (0.0045)
  - REER Misalignment: 0.0299*** (0.0009)
  - REER Misalignment X Economic Complexity Index: -0.0702*** (0.0021)
  - Economic Complexity Index: 1.6894*** (0.0322)
  - VIX (t-1): 0.0133*** (0.0033)
  - Observations: 299,586; R-squared: 0.0590; Number of firms: 38,790; Number of countries: 76.

### Robustness checks and subsample evidence
- Subsample analyses:
  - Manufacturing vs. non-manufacturing; tradable vs. non-tradable sectors — results mostly aligned with main findings.
  - Excluding China and India did not change differentiated results; findings held when excluding firms from these two countries.
  - Removing countries with very limited firm counts did not change results.
- Significance conventions: *** p<0.01, ** p<0.05, * p<0.1.
- All specifications include firm, year, industry-year, and country-year fixed effects; robust standard errors clustered by country.

### Concluding remarks
- Firm-level data document that real exchange rate movements affect corporate investment heterogeneously across countries.
- For most advanced economies, real depreciation is associated with higher investment (competitiveness channel).
- Emerging Asia mirrors advanced-economy behavior.
- Less complex economies often exhibit higher investment when the currency appreciates, consistent with cheaper imported capital goods boosting investment.
- Economic complexity is the key determinant of how real exchange rates affect corporate investment.

*Prepared by Steve Brito, Nicolás E. Magud, and Sebastián Sosa; Sections 1–3 of WP/18/107 (IMF Working Paper content provided).*

### Section 1

### Real Exchange Rates, Economic Complexity, and Investment — Section 1 (WP/18/107)

### Abstract and main empirical finding
- Firms in advanced economies and in emerging Asia increase investment when the domestic currency weakens, consistent with the Mundell-Fleming model.
- In other emerging market and developing economies, as well as in some advanced economies with a low degree of structural economic complexity, corporate investment increases when the domestic currency strengthens—consistent with Diaz Alejandro (1963), because capital goods are mostly imported and a stronger real exchange rate reduces firms’ investment costs.
- The degree of economic complexity helps reconcile these opposing effects: in more complex economies (generally advanced economies and emerging Asia) the competitiveness channel of a real depreciation tends to dominate; in less complex economies the imported-capital-cost channel tends to dominate.
- Using a simple measure of real exchange rate misalignment, most results carry through, except advanced economies that are less complex behave like non-Asian emerging markets: corporate investment increases when their currencies are overvalued.

### Theoretical framework (augmented Q-model of investment)
- Setup:
  - Firms produce tradable goods and purchase tradable investment goods (capital purchased abroad).
  - Objective: maximize discounted flow of dividends, D_t, with exogenous gross interest rate R.
  - Real exchange rate e: an increase denotes a real depreciation.
- Key equations and implications (as presented):
  - Dividend flow: D_t = π(K_t, θ_t, e_t) − e_t I_t − c(I_t, K_t).
  - Capital accumulation: K_{t+1} = I_t + (1−δ) K_t.
  - First-order condition leading to Tobin’s q: e_t + c_I(I_t,K_t) = (1/R) E_t[q_{t+1}].
  - With constant-returns-to-scale adjustment cost c(I_t,K_t) = (1/2) b (I_t/K_t − μ)^2 K_t, rearranged investment equation:
    - I_t/K_t = (1/(bR)) E_t[q_{t+1}] − e_t/b + μ.
  - Marginal value of capital and q dynamics given (equations (10)–(12) in the text).
- Comparative-static on real exchange rate:
  - ∂I_t/∂e_t expression (equation (14)) shows two opposing forces:
    - Competitiveness channel: a higher e (real depreciation) increases competitiveness and raises continuation value V_k, stimulating investment if V_{k e} − π_{K e} > 0.
    - Imported-capital-cost channel: a higher e raises the domestic cost of imported capital goods, reducing investment.
  - Net sign depends on relative strength of these channels; degree of economic complexity expected to influence these elasticities.

### Empirical strategy and advantages of firm-level focus
- Rationale for firm-level analysis:
  - Real exchange rate misalignment is exogenous to individual firms, mitigating reverse causality that plagues aggregate investment analysis.
  - Firm-level approach reduces endogeneity tied to aggregate current account adjustments and avoids problems related to investment deflators affected by real exchange rate movements.
  - Firm-level investment is nonetheless highly correlated with aggregate investment (authors note Figure 1 and Magud and Sosa (2017) document this).

### Data and descriptive statistics
- Dataset composition:
  - Unbalanced panel of 40,412 firms from 71 economies for the period 1995—2016 (annual frequency).
  - Firm-level source: Thomson Reuters Worldscope.
  - Country REER data: IMF’s International Financial Statistics.
  - Global VIX: Bloomberg, L.P.
- Sample cleaning and truncation:
  - Observations with inconsistent data dropped (negative values of total assets; capital expenditure; property, plant, and equipment; common equity; total debt; interest expenses; and depreciations).
  - Firm-level observations truncated below the 1st percentile and above the 99th percentile to avoid outliers.
  - For the investment ratio, leverage, and interest expense ratio truncation was applied only for observations higher than the 99th percentile because the 1st percentile value was zero.
- Coverage by firm type and industry:
  - Sample excludes financial firms (finance, insurance, real estate, public administration).
  - Industry distribution highlights:
    - Manufacturing: close to 52 percent of observations in the total sample.
    - Services: 14 percent.
    - Transportation, communications, and utilities: almost 10 percent.
- Country and regional composition:
  - Sample includes companies from 39 emerging market and developing economies and 32 advanced economies.
  - Sample skew: 28,199 firms (69.8 percent of the sample) from advanced economies and 12,213 firms (30.2 percent) from emerging market and developing economies.
  - Top-five country shares in the database: United States 19.1 percent; Japan 10.9 percent; China 7 percent; India 5.7 percent; United Kingdom 5 percent.
  - Share of companies in tradable sectors: 66.5 percent in emerging market and developing economies; 61.2 percent in advanced economies.
- Variable construction:
  - Investment-capital ratio (ICR) computed as capital expenditure divided by the total net value of property, plant, and equipment in the previous year.
  - ICR distribution is right-skewed, with a few companies investing more than 100 percent of their previous year’s capital stock (noted in Figure 2).

### Relation to the literature and contributions
- Closest studies and contrasts:
  - Alfaro and others (2017): find real depreciations associated with higher firm-level TFP growth and R&D investment in emerging Asia, but real appreciations in other emerging regions; no clear relationship in advanced economies. Key channel: relative response of exports and imports, i.e., export-intensity vs import dependence for capital goods.
  - Dao and others (2017): study REER and corporate investment with a different REER measure not trade-partner-weighted; focus on labor-cost channel.
  - Lanau (2017): examines regional differences on real depreciations and firm-level growth but does not analyze firm investment.
  - Avdjiev and others (2017); Druck and others (2018): document financial/U.S. dollar-cycle channels affecting emerging market firm investment via balance-sheet currency mismatches and income effects.
- Novel contribution:
  - Documents how the relationship between real exchange rate movements and firm-level investment varies across regions and production structures (degree of economic complexity), an angle not previously explored in the literature according to the authors.

*Prepared by Steve Brito, Nicolás E. Magud, and Sebastián Sosa; Section 1 of WP/18/107.*

### Section 2

### wp18107 - Section 2

### Summary statistics and sample composition
- For the full sample the mean of ICR is 0.27 and the median 0.15.
- Industry sample composition (No. of firms / Obs. / Percent of obs.):
  - Agriculture, forestry, and fishing: 496 / 4,126 / 1.2
  - Construction: 2,049 / 18,511 / 5.3
  - Manufacturing: 19,345 / 179,906 / 51.7
  - Mining: 2,433 / 15,844 / 4.6
  - Nonclassifiable: 1,093 / 9,112 / 2.62
  - Retail trade: 2,327 / 20,914 / 6.0
  - Services: 6,979 / 48,689 / 14.0
  - Transportation, communications, and utilities: 3,681 / 33,143 / 9.5
  - Wholesale trade: 2,009 / 17,904 / 5.1
  - Total: 40,412 firms / 348,149 observations / 100
- Table 2: Key summary statistics (71 countries, 1995-2016; full sample = 348,149 obs.)
  - Investment-capital ratio (ICR): Mean 0.27; Median 0.15; Std. Dev. 0.43; Min 0.006; Max 6.41
  - Tobin’s Q: Mean 1.46; Median 1.13; Std. Dev. 1.08; Min 0.29; Max 12.51
  - Cash flow: Mean 0.25; Median 0.22; Std. Dev. 2.65; Min -61.60; Max 20.00
  - Leverage: Mean 0.89; Median 0.50; Std. Dev. 1.27; Min 0.00; Max 12.70
  - Interest expense ratio: Mean 0.09; Median 0.05; Std. Dev. 0.17; Min 0.00; Max 2.61
  - Change in debt: Mean 0.25; Median 0.01; Std. Dev. 1.53; Min -6.31; Max 19.95
  - Sales growth: Mean 0.14; Median 0.07; Std. Dev. 0.46; Min -0.87; Max 6.17
  - Real Effective Exchange Rate Growth: Mean 0.38; Median 0.43; Std. Dev. 6.29; Min -74.07; Max 135.49
  - Real Effective Exchange Rate Misalignment: Mean -0.99; Median -1.04; Std. Dev. 12.47; Min -51.50; Max 371.19
  - Cboe Volatility Index (VIX): Mean 20.69; Median 22.07; Std. Dev. 6.07; Min 12.77; Max 32.55
- Emerging and Developing Economies (100,171 obs.) and Advanced Economies (247,978 obs.) reported separately in Table 2 with comparable ICR statistics (both medians ~0.15).

### Empirical approach
- Estimation method: diff-in-diff firm-level panel OLS with firm fixed effects; robust standard errors clustered by country.
- Baseline regression specification (dependent variable ICRj,c,t):
  - Includes lagged ICR (ICRj,c,t-1), country-level Real Effective Exchange Rate growth (REER_grc,t), firm-level controls Xj,t (Tobin’s q, cash flow, leverage, change in debt, sales growth), lagged VIX, and a set of year, industry-year, and country-year fixed effects.
  - Interpretation of coefficient γ on REER_gr:
    - γ < 0: firm-level investment increases when the domestic currency weakens in real terms.
    - γ > 0: firm-level investment increases when the domestic currency strengthens in real terms.
- Alternative specification: replace REER growth with REER_Mis (real exchange rate misalignment).

### Baseline regression findings (firm-level determinants)
- Standard signs and significance for firm-level variables:
  - Tobin’s q: positively related to firm investment (statistically significant).
  - Cash flow: positive relationship with capital spending; significant particularly for advanced economies.
  - Leverage (lagged): higher leverage reduces firm-level investment (negative coefficient).
  - Change in debt: an increase in debt is associated with higher investment (positive coefficient).
  - Sales growth (lagged): positive association with higher investment.
- VIX included to control for global uncertainty; coefficients vary by region and specification.

### Main results: REER growth and REER misalignment effects (regional heterogeneity)
- Table 3 — Coefficients on Real Effective Exchange Rate Growth (REER_gr), selected estimates:
  - Advanced (Col 1): REER_gr = -0.0053*** (s.e. 0.0003)
  - Emerging and Developing (Col 2): REER_gr = 0.0010 (not significant; s.e. 0.0828)
  - Developing Asia (Col 3): REER_gr = -0.0010*** (s.e. 0.0002)
  - Developing Europe (Col 4): REER_gr = 0.0049*** (s.e. 0.0013)
  - LAC (Col 5): REER_gr = 0.0005*** (s.e. 0.0001)
  - MENA (Col 6): REER_gr = 0.0274*** (s.e. 0.0026)
  - SSA (Col 7): REER_gr = 0.0080** (s.e. 0.0013)
- Interpretation from Table 3:
  - Firms in advanced economies and in developing Asia increase investment when the domestic currency weakens (negative coefficients).
  - For several emerging market regions (developing Europe, LAC, MENA, SSA) the coefficient is positive—firms invest more when the domestic currency strengthens.
- Economic magnitude:
  - A one-standard-deviation shock to the measure of real exchange rate misalignment shifts the investment-capital ratio by about 3-4 percentage points across regions.
  - Given sample ICR medians near 15 percent for both advanced and emerging economies, this represents a non-trivial impact on investment.
- Table 4 — Coefficients on REER Misalignment (REER_Mis), selected estimates:
  - Advanced (Col 1): REER_Mis = -0.0021*** (s.e. 0.0003)
  - Emerging and Developing (Col 2): REER_Mis = 0.0008 (s.e. 1.1125)
  - Developing Asia (Col 3): REER_Mis = -0.0018*** (s.e. 0.0001)
  - Developing Europe (Col 4): REER_Mis = -0.0052*** (s.e. 0.0007)
  - LAC (Col 5): REER_Mis = 0.0007*** (s.e. 0.0001)
  - MENA (Col 6): REER_Mis = 0.0134*** (s.e. 0.0013)
  - SSA (Col 7): REER_Mis = 0.0088*** (s.e. 0.0008)
- Robustness:
  - Replacing REER growth with REER misalignment yields broadly similar results except for emerging Europe where differences emerge.
- Plausible mechanism for positive coefficients in many emerging regions:
  - Dependence on imported capital goods: when currency strengthens (overvaluation), imported capital goods become cheaper, facilitating investment.
  - Economic complexity and production structure affect whether competitiveness (weak currency) or cheaper imported inputs (strong currency) dominates.

### Role of economic complexity (ECI)
- Economic complexity (ECI) used as proxy for knowledge intensity, diversification, and production capability.
- Regional patterns (Figure 4):
  - Advanced economies and developing Europe have higher ECI; Sub-Sahara Africa the lowest.
  - Developing Asia shows the highest increase in complexity since 1995 (index presented both standardized 0–1 and 1995=100 series).
- Quartile analysis (Table 5 and Table 6):
  - Countries in the lower quartile of ECI (less complex economies): coefficient on REER growth is positive — firm-level investment increases when domestic currency strengthens.
  - Countries in the upper quartile of ECI (most complex and integrated; upper quartile mainly includes advanced economies): coefficient on REER growth is negative — a weaker REER (real depreciation) is associated with higher firm-level investment.
  - Replacing REER growth with REER misalignment (Table 6) yields similar patterns, with the note that less complex advanced economies behave like emerging market and developing economies in requiring an overvalued currency to spur investment (corporate investment increases with overvaluation in those cases).

*Source: Authors’ calculations based on data from Thomson Reuters Worldscope; wp18107 - Section 2 (IMF working paper).*

### Section 3

### Section 3

### Economic complexity and firm-level investment: main findings
- Higher economic complexity is associated with higher firm-level investment (column 4 of Table 6).
- Economic complexity is related to the competitiveness channel: the interaction of real exchange rate growth and the Economic Complexity Index has a negative and statistically significant coefficient.
- For most advanced economies, investment increases when the real exchange rate depreciates, consistent with the Mundell-Fleming model and a competitiveness channel.
- Emerging Asia behaves similarly to advanced economies.
- For other regions of emerging market and developing economies, as well as for some advanced economies that are less complex, investment increases when the domestic currency appreciates — consistent with Diaz Alejandro (1963): these countries take advantage of temporarily cheaper imported capital goods associated with a stronger real exchange rate and increase investment.
- Conclusion: economic complexity determines the relationship between real exchange rates and corporate investment.

### Table 6: Selected coefficient estimates (dependent variable: investment-capital ratio (ICR))
- Sample: All Countries (column 4)
  - ICR (t-1): 0.0701*** (0.0085)
  - Tobin’s Q: 0.0427*** (0.0043)
  - Cash flow: 0.0045 (0.0038)
  - Leverage (t-1): -0.0203*** (0.0018)
  - Change in debt: 0.0455*** (0.0058)
  - Sales growth (t-1): 0.0003*** (0.0001)
  - REER Growth: 0.0071*** (0.0009)
  - REER Growth X Economic Complexity Index: -0.0084*** (0.0014) [reported in the first Table 6 panel]
  - Cboe Volatility Index (VIX) (t-1): -0.0193*** (0.0040)
  - Constant: 0.6345*** (0.0857)
  - Observations: 328,168
  - R-squared: 0.0869
  - Number of firms: 39,551
  - Number of countries: 76

- Sub-sample: Sample with ECI higher than percentile 75th (column 2, first panel)
  - ICR (t-1): 0.0097 (0.0211)
  - Tobin’s Q: 0.0470*** (0.0057)
  - Cash flow: 0.0012 (0.0054)
  - Leverage (t-1): -0.0164*** (0.0020)
  - Change in debt: 0.0426*** (0.0022)
  - Sales growth (t-1): 0.0007*** (0.0001)
  - REER Growth: -0.0006*** (0.0001)
  - Cboe Volatility Index (VIX) (t-1): -0.0003 (0.0029)
  - Constant: 0.1391** (0.0449)
  - Observations: 103,610
  - R-squared: 0.0904
  - Number of firms: 15,971
  - Number of countries: 76

- Sub-sample: Sample with ECI lower than percentile 25th (column 1, first panel)
  - ICR (t-1): 0.0603*** (0.0101)
  - Tobin’s Q: 0.0385*** (0.0052)
  - Cash flow: 0.0040 (0.0083)
  - Leverage (t-1): -0.0245*** (0.0036)
  - Change in debt: 0.0652*** (0.0086)
  - Sales growth (t-1): 0.0002*** (0.0001)
  - REER Growth: 0.0014*** (0.0005)
  - Cboe Volatility Index (VIX) (t-1): -0.0058 (0.0057)
  - Constant: 0.3918*** (0.1391)
  - Observations: 81,298
  - R-squared: 0.1023
  - Number of firms: 12,648
  - Number of countries: 42

- Table 6 (alternative specification with REER Misalignment and ECI; All Countries, column 4 of second panel)
  - ICR (t-1): 0.0755*** (0.0110)
  - Tobin’s Q: 0.0438*** (0.0045)
  - Cash flow: 0.0000 (0.0000)
  - Leverage (t-1): -0.0258*** (0.0027)
  - Interest expense ratio (t-1): -0.0072 (0.0068)
  - Change in debt: 0.0001 (0.0003)
  - Sales growth (t-1): 0.0364*** (0.0064)
  - REER Misalignment: 0.0299*** (0.0009)
  - REER Misalignment X Economic Complexity Index: -0.0702*** (0.0021)
  - Economic Complexity Index: 1.6894*** (0.0322)
  - Cboe Volatility Index (VIX) (t-1): 0.0133*** (0.0033)
  - Constant: -1.7298*** (0.0810)
  - Observations: 299,586
  - R-squared: 0.0590
  - Number of firms: 38,790
  - Number of countries: 76

- Sub-sample: Sample with ECI higher than percentile 75th (column 2, second panel)
  - ICR (t-1): 0.0185 (0.0202)
  - Tobin’s Q: 0.0498*** (0.0062)
  - Cash flow: 0.0000** (0.0000)
  - Leverage (t-1): -0.0142*** (0.0008)
  - Interest expense ratio (t-1): 0.0380*** (0.0094)
  - Change in debt: 0.0424*** (0.0015)
  - Sales growth (t-1): 0.0538*** (0.0109)
  - REER Misalignment: -0.0009*** (0.0001)
  - Cboe Volatility Index (VIX) (t-1): -0.0063** (0.0024)
  - Constant: 0.2951** (0.1112)
  - Observations: 95,792
  - R-squared: 0.0908
  - Number of firms: 15,337
  - Number of countries: 76

- Sub-sample: Sample with ECI lower than percentile 25th (column 1, second panel)
  - ICR (t-1): 0.0593*** (0.0107)
  - Tobin’s Q: 0.0412*** (0.0073)
  - Cash flow: 0.0000* (0.0000)
  - Leverage (t-1): -0.0229*** (0.0039)
  - Interest expense ratio (t-1): -0.0003 (0.0126)
  - Change in debt: 0.0683*** (0.0107)
  - Sales growth (t-1): 0.0220** (0.0101)
  - REER Misalignment: 0.0029*** (0.0002)
  - Cboe Volatility Index (VIX) (t-1): -0.0126 (6.3983)
  - Constant: 0.3631 (60.3613)
  - Observations: 66,162
  - R-squared: 0.1247
  - Number of firms: 11,520
  - Number of countries: 42

Notes on Table 6:
- All specifications include firm, year, industry-year, and country-year fixed effects.
- Robust standard errors (clustered by country) are in parentheses.
- Significance levels: *** p<0.01, ** p<0.05, * p<0.1.

### Robustness checks
- Sample splits: manufacturing vs. non-manufacturing firms; tradable vs. non-tradable sectors — results mostly aligned with main findings.
- Excluding China and India (which account for roughly 65 percent of firms in emerging Asia) did not change the differentiated results; results were broadly the same when excluding firms from these two countries.
- Removing countries with a very limited number of firms (and thus observations) did not change results; findings held.

### Concluding remarks (summary)
- Firm-level data document the impact of real exchange rate movements on corporate investment.
- For most advanced economies, depreciation of the real exchange rate is associated with higher investment, indicating competitiveness effects.
- Emerging Asia mirrors advanced-economy behavior.
- Less complex economies often see higher investment when the currency appreciates, consistent with cheaper imported capital goods boosting investment.
- Economic complexity is the key determinant of how real exchange rates affect corporate investment.

### Appendix: sample composition (selected country statistics)
- Total non-financial firms in sample (Emerging and Developing Economies table): 12,213; Tradable (%): 66.5; Manufacturing (%): 56.5; % of total the sample: 30.2
- Total non-financial firms in sample (Advanced Economies table): 28,199; Tradable (%): 61.2; Manufacturing (%): 50.2; % of total the sample: 69.8
- Selected country entries (No. of firms / Tradable (%) / Manufacturing (%) / % of total the sample):
  - Argentina: 886 / 61.4 / 44.3 / 0.2
  - Australia: 1,506 / 62.3 / 18.7 / 3.7
  - China: 2,845 / 71.0 / 62.5 / 7.0
  - India: 2,284 / 74.0 / 69.2 / 5.7
  - Japan: 4,404 / 49.0 / 41.2 / 10.9
  - Korea: 1,989 / 78.2 / 73.1 / 4.9
  - United States: 7,704 / 53.4 / 43.0 / 19.1
  - United Kingdom: 2,007 / 45.6 / 34.4 / 5.0
  - Taiwan Province of China: 1,887 / 83.6 / 78.0 / 4.7
- Full country-by-country breakdown and sample counts are presented in the Appendix table.

*Source: wp18107 - Section 3 (IMF Working Paper content provided).*

---


_Source: https://www.imf.org/-/media/files/publications/wp/2018/wp18107.pdf_