Sustainable Real Exchange Rates in the New EU Member States: Is FDI a Mixed Blessing?
This essay focuses on the various macroeconomic opportunities and challenges created by the foreign direct investment (FDI) inflows in the new Member States. We question whether the macroeconomic performance of the new Member States is furthered through the overall positive impact of FDI on the trade balance or whether FDI can actually worsen the performance. Our findings suggest that in some new Member States the positive impact, foreseen by the financial markets, may be reflected in a sustainable appreciation of the real exchange rate. Such real appreciation is in most cases moderate enough to allow for smooth nominal convergence required for euro adoption. In some cases, however, this appreciation is very fast, especially in the new Member States with an initial low net external debt and massive inflows, making it challenging to fulfill the Maastricht criteria. The Maastricht criteria may be difficult to meet also in those new Member States where FDI has been channeled predominantly into services, housing construction, or non-tradable sectors in general, and where it might be required to depreciate currencies in real terms to sustain the external balance. In these countries we observe increasing net external debt without a corresponding improvement in the trade balance.
KeywordsForeign Direct Investment Euro Area Real Exchange Rate External Debt Inflation Targeters
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