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The macroeconomic literature widely supports the existence of a robust association
between economic growth, trade performance and real exchange rate misalignment in terms of
undervaluation, especially for developing economies. Yet, in a world characterized with global
value chains (GVCs), the previous strands of literature become debatable as they assume that
countries export only final goods that do not require any imported intermediate inputs. Thus,
using a cointegration analysis for 143 countries over the period 1995-2018, this paper assesses
the impact of real exchange rate (RER) misalignment on the two main components of GVC
participation: first, the domestic value added of a country which is embodied in the exports of
other countries (Forward GVC Participation); second, the foreign value added embodied in a
country's exports (Backward GVC Participation). Moreover, it investigates how this impact is
contingent to additional factors such as the quality of institutions, the degree of digitalization
and the country's position within the value chain: upstream or downstream country. The main
findings show that RER misalignment exerts a positive impact on both the forward and
backward components of GVC participation. Moreover, misalignment is found to be a counter-
productive policy instrument for promoting GVC participation in countries with good quality
of institutions. However, it proves to be more beneficial for countries with a higher level of
digitalization. Considering the country's position within the value chain, the results show that
downstream countries are better cushioned from exchange rate changes. The robustness of the
results is confirmed after controlling for the endogeneity of RER misalignment using an
instrumental variable approach, investigating whether the impact of RER misalignment is
primarily driven by positive values (undervaluation) or negative values (overvaluation),
running the regressions using Driscoll-Kraay robust standard errors, and utilizing alternative
indicators for the quality of institutions, and for the degree of digitalization.
