Aid for Trade and the Real Exchange Rate

The current analysis contributes to the literature on the real exchange rate effect of development aid by separating the real exchange rate effect of the development aid allocated to the trade sector (Aid for Trade – AfT) from the effect of other aid flows. The empirical findings show that higher AfT flows lead to a depreciation of the real exchange rate in recipient economies, while other development aid flows generate an appreciation of the real exchange rate. The real exchange rate effect of total AfT flows works through trade openness, export product diversification, and inward foreign direct investment stock.