Stronger US dollar boosts risks for emerging markets

Singapore, June 29, — The strengthening US dollar since mid-April has led to sharp currency depreciation and significant declines in foreign exchange reserves in a number of emerging and frontier market countries including three in Latin America , increasing credit risks for those with large external funding needs, Moody’s Investors Service said in a report today.

The report looks at the external exposure of 40 emerging and frontier market sovereigns with some of the highest levels of external debt, either in US dollar terms or in relation to the size of their respective economies.

Some countries among the most vulnerable to a stronger US dollar are Argentina (B2 stable), Ghana (B3 stable), Mongolia (B3 stable), Pakistan (B3 negative), Sri Lanka (B1 negative), Turkey (Ba2 Review for downgrade), and Zambia (B3 stable).  Chile (Aa3 negative), Colombia (Baa2 negative), Indonesia (Baa2 stable) and Malaysia (A3 stable) are also exposed, but financial and institutional buffers lower near-term vulnerability.

“Countries with large current account deficits, high external debt repayments and substantial foreign-currency government debt are most exposed to the impact of a stronger US dollar,” said Alastair Wilson, Moody’s Global Managing Director of the Sovereign Risk Group. “To the extent that these currency fluctuations reflect capital outflows or significantly lower external inflows, they are credit negative for sovereigns with large external funding needs.”

Emerging markets that have been prone to large shocks to external financing conditions in the past are — all else equal – more likely to experience large shocks now unless past shocks led to adjustments that reduced their reliance on external funding.

In 2014, Hungary, Malaysia, Mongolia and Russia were among those that experienced particularly large shocks to their external financing conditions. In the period since then, Angola (B3 stable), Kenya (B2 stable), Indonesia and Sri Lanka experienced relatively large negative shocks. Of these, Kenya, Mongolia, Sri Lanka and Zambia remain highly vulnerable, implying high structural hurdles to lowering reliance on external financing.

Brazil (Ba2 stable), China (A1 stable), India (Baa2 stable), Mexico (A3 stable), and Russia (Ba1 positive) are among the least vulnerable to tightening external financing conditions because of their low reliance on external capital inflows.

Sustained and severe shocks to external financing conditions can have credit implications, in particular when they result in a significant further erosion of financial buffers, raise liquidity risks and/or take fiscal metrics onto a more unfavorable path than Moody’s had previously expected.