In a period marked by heightened economic uncertainty and recurring episodes of financial instability, cross-border investment activity offers valuable insight into what may lie ahead for economic growth and currency movements. Rather than reacting solely to traditional macroeconomic indicators, investors and policymakers may gain earlier and more nuanced signals by observing how firms deploy capital across national borders.

This conclusion emerges from research by Steven Riddiough, an associate professor of finance at the University of Toronto Scarborough and the Rotman School of Management, together with Huizhong Zhang of Monash University. Drawing on nearly twenty-five years of data covering cross-border mergers and acquisitions among more than forty developed and emerging economies, the researchers identify a systematic relationship between changes in foreign investment activity and subsequent shifts in both economic growth and exchange rates.

Their findings are particularly relevant for global investors and for those responsible for economic policy, where accurate expectations about future conditions are essential. While standard economic theory often suggests that exchange rates should reflect underlying fundamentals such as growth differentials, productivity, or inflation, empirical studies have struggled to demonstrate a strong and consistent link in practice. This research helps to bridge that gap by pointing to a different source of information: the investment decisions of firms themselves.

Cross-border merger and acquisition announcements, the authors argue, function as a clear and observable signal of changing expectations about economic fundamentals. Such deals reveal firm-level, or “microeconomic”, information that is typically private and difficult for markets to observe directly. Companies contemplating significant international investments are operating close to real economic conditions within their industries, allowing them to form informed views about future demand, profitability, and growth. When these firms commit capital across borders, that information becomes public, influencing the expectations of other market participants and, ultimately, currency values.

This micro-level perspective contrasts sharply with the macroeconomic data most commonly used to assess future growth. Indicators such as GDP releases, labour market statistics, inflation, or interest rates provide economy-wide snapshots, but they are often backwards-looking and released with a delay. By comparison, firms operate at the “coal face” of the economy, offering a more immediate sense of emerging trends. Their investment choices, therefore, contain forward-looking information that markets can incorporate rapidly.

Empirically, the study finds that massive investment outflows from a country are followed by a depreciation of that country’s currency in the subsequent month, along with an approximate one per cent decline in economic growth over the following five years. Conversely, countries receiving unusually high levels of foreign investment experience around a one per cent increase in growth over a similar horizon, alongside an appreciation in their currency shortly after the investment surge.

The analysis focuses on aggregate trends in investment flows rather than the outcomes of individual deals, with results most informative for domestic economic conditions. In particular, outward investment appears more revealing than inward flows. Elevated international acquisition activity by domestic firms tends to signal future economic weakness at home, while lower-than-usual outward investment is associated with stronger subsequent domestic performance.

More information: Steven Riddiough et al, Cross-Border M&A Flows, Economic Growth, and Foreign Exchange Rates, Review of Financial Studies. DOI: 10.1093/rfs/hhaf109

Journal information: Review of Financial Studies Provided by University of Toronto, Rotman School of Management