The excessively strong dollar, which is getting stronger and will continue to do so as the Fed continues to hike interest rates, could devastate emerging economiesis a serious threat and should not be taken lightly.
The current US dollar is the strongest it has been in the last two decades. Its value has increased because the Federal Reserve has drastically increased interest rates to combat inflation and because America’s economic health is better than most industrialized nations, despite its problems. It is, in essence, the currency of refuge in the markets.
This strength has become the weakness of the world. The dollar is the de facto currency for world trade and its strength is putting pressure on the finances of dozens of nations. low-income, mainly those that depend heavily on food and oil imports, and borrow in dollars to finance them. Although the most developed emerging nations are not having a good time either.
Higher food and energy costs, exacerbated by Russia’s war with Ukraine, were already hurting emerging market countries.
The rise of the dollar whose strength is measured against a basket of currencies representing major US trading partnershas compounded these problems by making it even more expensive to import vital commodities using weaker currencies.
The mechanism
A strong dollar forces countries to use more of their own currency to buy the same amount of goods. The higher price means they are inadvertently importing more inflation along with what they buy.. Additionally, and because they borrow in dollars, they have to pay interest in dollars, which increases their financial difficulties with a stronger greenback and higher rates in the same currency. Inadvertently (and often not so much), this super-dollar is generating public finance deficits in several nations and additional indebtedness. The problem is that, over time, this deficit position and greater indebtedness will be a drag on finances.
nations in trouble
According to the rating agency S&P Global Ratings, so far this year four emerging market countries have defaulted on their debts: Russia, Sri Lanka, Belarus and Ukraine. Additionally, another ten are in “serious stress”: Argentina, Lebanon, Ghana, Suriname, Zambia, Ethiopia, Burkina Faso, the Republic of Congo, Mozambique, and El Salvador.
Also, of the 94 emerging market sovereign debt funds that S&P rates worldwide, more than a quarter are rated B-minus or below, a low-quality rating indicating a high-risk investment.
The damage to public finances translates into other impact indicators for the common citizen. About 22 million people in Ghana, or a third of its population, reported a decline in their income between April 2020 and May 2021, according to a World Bank and UNICEF survey. Adults in nearly half of the households with children surveyed said they skipped a meal a day because they didn’t have enough money. Nearly three-quarters said prices of major foods had increased.
As costs skyrocketed during the pandemic, governments took on more debt. Ghana’s public debt grew to nearly $60 billion from about $40 billion at the end of 2019, or nearly 80 percent of its gross domestic product from around 63 percent, according to Moody’s.
Another example: In 2016, Ghana borrowed $1 billion over 10 years, paying an interest rate of just over 8 percent. As the financial situation of the country and the world has worsened and investors have pulled back, the yield, indicative of what it would now cost Ghana to borrow money through 2026, has risen just over 35 per cent.
It is an unsustainable cost of debt for a country in the situation of Ghana. But it is not the only country that is experiencing difficulties, and if they think that other regions such as Latin America are very far from this situation, it is a serious mistake.
Recently Jesse Rogers, economist at Moody’s Analytics said that the risk of a sovereign debt crisis in some emerging markets is “very, very high”, while comparing the current situation with the debt crisis that crushed Latin American economies in the 1980sthe last time the Fed tried to quell runaway inflation.
More than $80 billion has been withdrawn this year from mutual funds and exchange-traded funds, two popular types of investment products, that buy emerging-market bonds, according to EPFR Global, a data provider. As investors sell, the United States is often the beneficiary, further strengthening the dollar. 2022 is by far the worst year for capital outflows the market has ever seen.
Even citizens of some countries are trying to exchange their money for dollars, fearful of what is to come and of further depreciation of their currencies, but inadvertently contributing to it as well. For pockets of emerging markets, this is a really complex context and one of the most challenging scenarios in modern history.
Latin America in general is not far from equally complicated scenarios, the super-dollar is putting pressure on public finances in practically the entire region.
We already discussed how Argentina’s economy is in serious stress, but there are countries like Colombia, Chile, Peru and Boliviathat they will not be able to put up with such a powerful dollar much longer without suffering any damage.
And the two Latin American giants? They are not saved either. Brazil and Mexico are getting more indebted, the size of their economies makes them import more and more inflation and, despite the fact that their currencies have relatively withstood (plus the Mexican peso), the storm would change, there is no guarantee that nothing will happen .
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