Moody's: Stronger US dollar hurts countries with large external financing needs

The strengthening US dollar has created external pressures in some countries, as reflected in weakened currencies and declining foreign exchange reserves, Moody's Investors Service says in research published today. To the extent that these pressures reflect capital outflows or significantly lower inflows, they hurt countries with large external funding needs.

Moody's report, entitled "US Dollar Strength Hurts Countries with Large External Financing Needs", is an update to the markets and does not constitute a rating action.

"The anticipated rise in US interest rates and subdued growth prospects for some countries are making investment in these markets less attractive," says Marie Diron, Senior Vice President and co-author of the report.

Moody's report says the current pressure is on a similar scale to mid-2013 when financial markets adjusted to the possibility of tighter US monetary policy.

For countries with large pending external debt payments - such as Malaysia, Turkey and Chile --marked depreciations of their exchange rates make it more expensive for corporations to service foreign currency debt. It could also crimp the willingness of foreign creditors to refinance local currency external debt.

In addition, countries with large current account deficits, such as Turkey and South Africa, are vulnerable to external pressures because they may find it more difficult to finance their deficits.

Moreover, for some countries, falling commodity prices weigh on export revenues, lowering current account surpluses or increasing deficits. Chile, Colombia, Malaysia and Peru are among the commodity exporters that have faced external pressures.

In Brazil, Colombia and Mexico, central banks have preserved foreign exchange reserves and allowed the value of their respective currency to depreciate. However, in Malaysia and Chile, central banks have used their reserves to try to stop even larger depreciations.

"The erosion of reserves buffers is credit negative for sovereigns," adds Ms. Diron, "most particularly in countries where reserves are relatively low in relation to forthcoming external debt repayments."

By contrast, foreign exchange reserves in India and Indonesia have risen and their nominal effective exchange rates have not depreciated as significantly as elsewhere. In both cases, current account balances have improved since 2013 and capital flows have accelerated in anticipation of policy reforms following political transitions in 2014, bucking the general emerging market trend of lower capital inflows.

However, Indonesia's higher exposure to lower global commodity prices and greater reliance on foreign financing has resulted in some exchange rate depreciation in recent weeks. In India's case, improving growth prospects have drawn significant equity capital inflows and the risk to its external position lies in growth or policy disappointment over coming months leading to outflows.