The Financialization of Water Scarcity: Exchange Rate Dynamics and Virtual Water Flows in Wheat Trade

Water-stressed regions remain net exporters of virtual water, water volume embedded in traded goods to areas with abundant water resources, despite accelerating climate change impacts. We investigate whether exchange rate dynamics and systemic real exchange rate misalignments influence persistent imbalances in virtual water trade. We employ rigorous panel regressions with fixed or random effects on major wheat-exporting and importing countries, alongside relevant control variables. Our findings indicate that currency depreciations and persistent undervaluation stimulate exports and reduce imports of virtual water, thereby intensifying water outflows. Conversely, currency appreciations and sustained overvaluations increase virtual water imports and discourage exports, resulting in higher water inflows. These results suggest that exchange rate instability and misalignment indirectly contribute to transboundary water mining by channeling virtual water flows toward overvalued currencies. Policymakers should incorporate exchange rate management strategies into virtual water balances. Hedging instruments that mitigate depreciations, along with the avoidance of competitive devaluations, may prove essential for achieving water sustainability objectives.