By Jamie McGeever
ORLANDO, Florida (Reuters) – A strong U.S. dollar and high Treasury yields pose major challenges for emerging economies, and policymakers have no easy way to counter the powerful punk. one-two this.
With America's independence casting a shadow over the rest of the world, many emerging markets (EM) are facing weaker currencies, higher costs to service dollar-denominated debt, capital flows depression or even capital flight, reduction in local asset prices and slow growth.
In addition there is the uncertainty and anxiety about the proposed tariffs and trade policies of the US government.
History has shown that when such trends take hold in emerging markets, they can create vicious cycles that accelerate quickly and are difficult to break.
Unfortunately, there seems to be no simple road map to avoid this.
Just look at China and Brazil.
The monetary and fiscal paths followed by these two EM heavyweights could not be more different. Beijing promises to ease monetary and fiscal policy to revive its economy; Brasilia is promising significantly higher interest rates and trying to get its fiscal house in order.
Their divergent paths – and ongoing struggles – suggest that wherever EM economies stand in terms of growth, inflation and fiscal health, they are likely to face a difficult road ahead in the coming years.
GO WITH THE PEOPLE
It is clear that Brazil and China are in very different places, especially in terms of inflation. Brazil has a lot of it, prompting aggressive actions and guidance from the central bank. China, on the other hand, is fighting against inflation, and is finally starting to cut interest rates.
Another difference is the fiscal room each has to generate growth. Brazil's reluctance to cut spending enough is a major reason for the decline of the real and the tightening of the central bank's gaze. The market forces Brasilia's hand.
The market is also putting pressure on Beijing, but pushing it in the other direction. The general size of the support packages and measures announced since September to revive economic activity runs into the trillions of dollars.
But even if the methods are diametrically opposed to the tactics of the two countries, the results so far have been similar: slow growth and weak currencies, a picture that most emerging countries will recognize. crop Brazil's real has never been weaker and the tightly regulated yuan is close to the times it was last visited 17 years ago.
As Reuters exclusively reports, China is debating whether to weaken the yuan in response to looming US tariffs, and analysts at Capital Economics warn it could drop as low as 8.00 per dollar.
But there is no risk in letting the yuan depreciate. Doing so could accelerate capital flows, and spark 'beggar thy neighbor' FX devaluations across Asia and beyond.
A race to the bottom for EM currencies would be very difficult for the countries involved, as the dollar is now a bigger driver of EM flows than interest rate differentials, according to the Bank for International Settlements. national. Analysts at State Street (NYSE:) rated exchange rates explain about 80% of local EM sovereign debt returns.
The Institute of International Finance estimates that capital flows to emerging countries will decrease next year to $716 billion from $944 billion this year, a drop of 24%.
“Our forecast is based on a baseline scenario, but significant risks remain,” the IIF said.
COMING FINANCIAL RULES
EM countries also face headwinds from higher US bond yields.
Although the pool of hard currency sovereign and corporate debt is small compared to local currency debt, it is rising. Total (EPA:) emerging market debt is now close to $30 trillion, or about 28% of the global bond market. That number was 2% in 2000.
And the pressure from higher borrowing costs is being felt in real time. Emerging market financial conditions are at their tightest in almost five months, according to Goldman Sachs, with the rise in recent months almost entirely due to rate hikes.
Real interest rates are much higher now than they were during Trump's first presidency. But it may be difficult for many countries to cut them, because that could “create financial stability concerns by putting pressure on exchange rates,” JP Morgan analysts warn.
On the positive side, emerging countries have large FX reserves to fall back on, especially China. Most of the world's $12.3 trillion FX reserves are held by emerging countries, with $3.3 trillion in the hands of China alone.
Finding themselves caught between a rock and a hard place, EM policymakers may soon be forced to dip into this stash.
(The views expressed here are those of the author, a columnist for Reuters.)
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