Beware, the Strengthening of the US Dollar Has Often Preceded Financial Storms, Especially in the 90s.
More and more countries could end up in default.
From an emerging country perspective, the surge in the US dollar is breathtaking. Since the beginning of 2022, the greenback has appreciated by 39% against the Ghanaian cedi, 28% against the Turkish lira, and 45% against the Sri Lankan rupee. In August 2022, the World Bank calculated that emerging market currencies had lost an average of 11% of their value against the dollar since January 2022.
In other words, every good imported in US currency has seen its price rise by 11%.
This is in addition to the increase in food and energy costs since the war in Ukraine began on February 24, 2022, and is fueling the price surge in developing nations, further weakening the poorest.
“Companies in these regions are spending more on imports, which may reduce their investments,” said Marcello Estevao, head of the macroeconomics, trade, and investment department at the World Bank. The only positive note is that the devaluation of the currencies of low- and middle-income countries is making their exports to the United States more competitive.
The appreciation of the US dollar, which has often preceded severe financial storms, has left only bad memories for emerging countries.
In 1994, for example, the Federal Reserve's (Fed) sudden rate hike triggered a flight of capital from Mexico, a rapid depreciation of the peso against the greenback, and, ultimately, a contraction in Mexican gross domestic product (GDP). A few years later, in 1997 and 1998, the Southeast Asian tigers (Thailand, Malaysia, the Philippines, and Indonesia) were in turn caught up in the turmoil. In 2013, the prospect of a tightening of US monetary policy caused investors to panic and repatriate their capital to the richer states.
The strong dollar has long been the weakness of emerging markets. Indeed, emerging countries need to borrow in US currency to finance their development, but are at the mercy of the Fed's monetary policies. However, the lessons of previous crises have been learned. Emerging countries, especially in Asia, have developed their bond markets in local currencies to be less dependent on the dollar and their central banks have strengthened their foreign currency reserves to better resist capital outflows.
In 2022, central banks have also become better prepared. “Several emerging market countries, such as Brazil, Chile, Poland, and Russia, have raised policy rates ahead of the U.S. tightening cycle, thereby reducing the potential for capital outflows,” observed rating agency FitchRatings, in February 2022.
In previous cycles, emerging market rate hikes often lagged those of the US.
Destabilization
While the public debt of several large emerging countries, including Brazil, Mexico, and India, has been contracted in local currencies in recent years, countries such as Argentina, Ethiopia, and Kenya remain highly exposed. The appreciation of the dollar is adding dangerously to their debt burden. The debt burden has increased sharply over the past decade, in particular, to cope with the COVID-19 pandemic.
FitchRatings has calculated that the median public debt of emerging countries rose from 18% to 31% of their GDP between 2013 and 2021. In Africa, its repayment exceeded the threshold of $100 billion per year in 2021. Several countries, such as Sri Lanka and Namibia, have already declared themselves in default and the list could grow.
Nearly a quarter of emerging countries and more than 60% of low-income countries are facing severe debt-related difficulties, warned the Managing Director of the International Monetary Fund, Kristalina Georgieva, on Tuesday 13 September 2022.
The most likely scenario is that of destabilization of small or vulnerable economies, such as Pakistan or Sri Lanka, without this spreading to the whole group of emerging countries, unlike previous crises. According to data provided by the Institute of International Finance (IIF), an association of private investors, the situation should improve.
According to this organization, in August 2022 emerging countries attracted $27 billion in foreign capital, after five consecutive months of outflows. “Rising U.S. rates have been the main cause of capital outflows from emerging markets,” the IIF noted in late July 2022. “Now, with Fed rate hikes no longer as urgent, emerging markets may stabilize and consolidate.”
A view that is far from unanimous, however. With China's economic slowdown and the war in Ukraine, the period of uncertainty will continue and the US dollar will continue to appreciate as a safe haven.
Some reading
The Strong Dollar Is a Danger to the World Economy, and It Has Already Taken Its First Victims. The dollar's rise is probably not over.
Bitcoin Is Not an Enemy, but an Ally in the Fight Against Climate Change. Governments should open their eyes to fully exploit the potential of Bitcoin rather than trying to harm this people's revolution.
Who Is the Current Winner of the War in Ukraine? America and It Is the US Dollar That Tells Us So. The impressive strength of the US dollar does not lie.
Rather Than the End of Abundance, It Is Sustainable Abundance That We Must Aim for. Emmanuel Macron is wrong.
An American Student Trader Pockets $110M in One Month and Becomes the New Prince of Wall Street. Lucky guy or genius?
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