Real Exchange Rate Overvaluation and WTO Dispute Initiation in Developing Countries

Why and when do developing countries file trade disputes at the World Trade Organization (WTO)? Although financial conditions have long been considered an important driver of trade policy, they have been largely absent from the literature on trade disputes. We argue that developing country governments bring more trade dispute to the WTO when overvalued real exchange rates put exporters at a competitive disadvantage. This dynamic is most prevalent in countries where large foreign currency debt burdens discourage nominal currency devaluations that would otherwise serve exporters’ interests. Our findings provide an explanation for differences in dispute participation rates among developing countries, and also suggest a new link between exchange rate regimes and trade policy.