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.
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 strengthening of the US dollar, 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. "As a result, we've seen sharp currency depreciations in some countries and big falls in foreign exchange reserves in others."

Moody's report says the current pressure on several emerging markets is on a similar scale to mid-2013 when financial markets adjusted to the possibility of tighter US monetary policy. However, the impact has not been uniformly severe.
Countries with large current account deficits, such as Turkey and South Africa, are vulnerable to weaker capital flows and could find it more difficult to finance their deficits.

In addition, falling commodity prices weigh on export revenues and result in smaller current account surpluses or larger deficits for commodity exporters such as Chile, Colombia, Malaysia and Peru.

And countries with large pending external debt payments such as Turkey, Malaysia and Chile are exposed to marked exchange rate depreciation because it increases the cost of servicing foreign currency debt and, potentially, local currency external debt.

But not all countries are as exposed to current pressures as in 2013. In India and Indonesia, for example, foreign exchange reserves have risen and exchange rates have not changed significantly. In both cases, current account balances have improved since 2013 and capital inflows increased in anticipation of economic and fiscal reforms following political transitions in 2014, bucking the general emerging market trend of lower capital inflows.

And policy responses have limited the impact in a number of countries. Turkey's central bank left interest rates unchanged this month. Further cuts would have increased concerns about political interference in the central bank's decision and weighed on the currency. In Brazil, Colombia and Mexico, central banks chose to preserve foreign exchange reserves and allowed the value of their respective currency to depreciate. In contrast, in Malaysia and Chile, central banks used reserves to try to stop even larger depreciations.

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