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The rest of the world is groaning as the U.S. dollar is so strong.
Emerging markets as well as developed countries such as Europe are exposed to the impact of a strong dollar, but relatively net exporters may not face significant risks, the Wall Street Journal (WSJ) diagnosed on the 22nd (local time).
According to the newspaper, the WSJ Dollar Index, which measures the value of the US dollar against 16 currencies, rose 8.7% in the first half of this year, the largest increase since 2010.
As of July, the WSJ Dollar Index was up 1.4% as of the previous day.
Currencies in emerging markets are under significant downward pressure as investors turn to the dollar amid economic uncertainty. Even the euro was the weakest in 20 years since 2002, when the parity (1 euro = 1 dollar) broke and fell below the 1 dollar last week.
The biggest reason for the strong dollar is the steep rise in interest rates by the US central bank, the Federal Reserve (Fed). Following the first ‘giant step’ (0.75 percentage point increase in interest rate at a time) last month for the first time in 28 years, the Fed predicted the same level of rate hike in July.
Another reason for the strong dollar is that investors are flocking to the US market as the economic conditions of other countries are weaker than that of the US. The influx of foreign investors into the U.S. stock and bond markets is an explanation that strengthens the dollar.
The International Finance Association (IIF) estimates that there was a net outflow of $4 billion in emerging markets last month.
Excluding China, net outflows from emerging markets are similar to those of past macroeconomic crises, said Robin Brooks, chief economist at IIF. However, it is still lower than the initial level of the novel coronavirus infection (COVID-19) pandemic.
Countries that have issued foreign currency denominated bonds could become more at risk if their currencies depreciate and their debts to repay substantially increase.
Sri Lanka, which went into default in May due to a ‘combo’ shock of debt crisis and inflation, is a typical example.
Countries with high dollar-denominated debt could also be at the epicenter of the crisis.
According to the IIF, dollar-denominated debt in countries such as Argentina, Ukraine and Colombia exceeds 20% of their gross domestic product (GDP), compared to less than 2% in some countries in Asia and Europe.
Marcelo Estebau, director of global macroeconomics, trade and investment at the World Bank, said: “All countries with large dollar-denominated debt are a concern.”
Thus, governments can hedge the risk of depreciating their currency by holding assets in foreign currencies, the WSJ noted.
While sub-Saharan African countries with smaller economies are still vulnerable, net exporters, who export more than imports, will be able to overcome the strong dollar well because they have access to the US dollar, the newspaper said.
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