Real Exchange Rate Misalignment and Agricultural Export Performance in Developing Countries

The influence of fluctuating currency values on agricultural trade has been acknowledged, especially since the demise of the Bretton Woods system of fixed exchange rates. Following G. E. Schuh's pioneering articles linking exchange rates to country performance in the global agricultural market, several attempts were made to quantify the effects of nominal and real exchange rate movements on agricultural trade.' Recently, another body of literature emerged aimed at quantifying the effects of exchange rate risk on trade.2 Despite these studies, inadequate attention has been directed toward analyses of underlying policies that directly influence real exchange rates and that indirectly affect trade performance. Specifically, the issue of incorrect real exchange rate alignment has been ignored. Real exchange rate misalignment occurs in markets in which actual exchange rates are not allowed to adjust to changes in economic fundamentals. Unsustainable monetary, fiscal, and various trade and exchange control policies are its principal cause. Calculation of misaligned exchange rates is dependent on the ability to disentangle equilibrium from disequilibrium disturbances affecting movements in actual real exchange rates. Quantification represents a major challenge. Purchasing power parity (PPP) provides the simplest way to estimate misalignment. However, real exchange rate deviations from PPP often do not indicate incorrect alignment of the real exchange rate because the actual rate ought to vary in response to external or internal shocks that modify the equilibrium rate. Ideally, misalignments are measured using real exchange rates that are permitted to vary in response to changed economic conditions. The changing path of real equilibrium exchange rates is somewhat elusive and can be identified using a structural model.