What Damage Can a Strong Dollar Do to Emerging Markets?
The U.S. Federal Reserve Bank lifted its benchmark interest rates by 25 basis points in March 2022 and another 50 points in May, after holding them at or near zero for years. Additionally, it hinted that it might increase rates many more times in 2022 alone as it fights to keep inflation in check in the United States.
This results in higher interest rates for American consumers who want to finance a home or a car. Because the financing costs will be greater, American enterprises will have less motivation to expand.
Additionally, a stronger dollar and more interest in investments denominated in dollars generally are results of this. In anticipation, the dollar's value reached a 20-year high.
Knowing How a Strong Dollar Can Affect Developing Countries
Concerns over rising interest rates and a stronger dollar in emerging markets primarily fall into two categories:
As money invested abroad returns to the safer bounds of the United States, capital outflows will turn around.
Higher interest rates will make it more expensive for governments and corporations that borrow money abroad to get finance and settle their debts.
Poor timing
The timing of the interest rate increases is particularly unfavourable for emerging market countries. Many people rely significantly on tourism, which almost stopped during the COVID-19 pandemic for two years.
As of the end of April 2022, the U.S. dollar was already on the rise, having increased by 8% in a single year to a two-decade high.
COVID's Impact
According to an analysis by investment research firm Neuberger Berman, sovereign debt defaults by emerging nations had reached 7.8 percent by mid-2020, a level not seen since 2001.
Only monetary injections from the World Bank, the IMF, and "Chinese organisations" were able to ameliorate the situation in some countries.
Capital Exits
The U.S. and other affluent countries' foreign investment flows are crucial to the majority of emerging markets. Their economy and businesses benefit from the funding. Their current account or fiscal deficits are financed in part by the cash.
there are two significant aspects about capital inflows to emerging nations that must be remembered: They are erratic, changing their minds exactly when those countries need them the most.
Funding the "twin deficits" may become more challenging as investment returns in the United States increase. This could cause international capital flows away from emerging nations to quicken.
The purpose of the interest rate rises is to reduce inflation in the United States, but they also have the unintended consequence of making inflation in other countries—not just emerging-market countries—worse.
The Pressure of Debt
The rising cost of debt in US dollars is the second drawback of increased US interest rates on developing countries.
To strengthen their finances, governments, businesses, and banks in emerging markets took advantage of low-cost borrowing.
This is doubly troublesome because it may be more challenging to service this dollar debt if local currencies devalue as a result of a change in capital flows. If their earnings don't rise at a rate that matches their borrowings, businesses and banks that took out dollar-denominated loans may come under further pressure.
Estimates of precisely which nations are most vulnerable vary greatly and frequently.
According to the Federal Reserve, Hungary, Peru, Turkey, and Poland were at the top of the list of nations most susceptible to Fed rate rises because of their high levels of foreign-denominated debt as of 2021.
Is it better for emerging markets if the dollar is strong or weak?
In general, everyone benefits from a weaker dollar except Americans. American exports are more affordable for international customers when the value of the dollar declines. Foreign capital pours in, looking for higher returns than those offered in the United States. Because interest rates are still low, paying off debt is simpler.
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