Dollar strength hurting emerging markets with heavy financing needs, Moody's says

The strengthening of the US dollar is denting investor confidence in emerging markets exposed to heavy external debt financing, according to Moody’s.

In a report published on Monday, the rating agency said the situation had created external pressures in some emerging markets with weakened currencies and declining foreign exchange reserves.

However, Moody´s also noted that many markets were weathering the situation much better than they did in 2013; the last point of adjustment to the possibility of tighter US monetary policy.

Marie Diron, Senior Vice President at Moody’s and a co-author of the report, said countries with large current account deficits, such as Turkey and South Africa, were among the more vulnerable.

“They’ll be susceptible 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.”

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

"A combination of the strengthening of the US dollar, an anticipated rise in US interest rates and subdued growth prospects for some countries are making investment in these markets less attractive," Diron said.

The result has been sharp currency depreciations in some countries and big falls in foreign exchange reserves in others. However, Moody’s says India and Indonesia have defied the broader trend.

“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,” Diron observed.

Policy responses have also served to limit the impact in some cases. For instance, the monetary authorities in Brazil, Colombia and Mexico chose to preserve foreign exchange reserves and allowed the value of their respective currencies to depreciate.

By contrast, in Malaysia and Chile, central banks used reserves to try to stop even larger depreciations during what represents a trying phase for emerging markets.