The U.S. dollar has been quickly appreciating and further strength in the greenback could put further pressure on some emerging markets and country-specific exchange traded funds.
For instance, Oxford Economics warned that Malaysia, Chile and Turkey were among the emerging markets most at risk of a stronger USD, reports Ansuya Harjani for CNBC.
“A simple textbook view of the issue might be that a rise in the dollar’s value could be good for emerging markets as it would improve their export competitiveness vis-à-vis the U.S.,” Adam Slater, senior economist at Oxford Economics, said in a report. “[But], there are a number of channels through which a stronger dollar may damage growth in emerging market countries.”
Slater identified six factors that could weigh on these at risk countries, including net commodity exports as a percentage of gross domestic product, inflation, private debt as percentage of GDP, total external debt as a percentage of GDP, short-term debt as a percentage of foreign exchange reserves and debt-weighted exchange rate movement since mid-2014.
An appreciating greenback increases the burden of dollar-denominated debt, lowers commodity prices and impedes capital inflows. [Strong USD Forces Down Emerging Market ETFs]
Over the past year, the iShares MSCI Malaysia ETF (NYSEArca: EWM) declined 11.6%, iShares MSCI Chile Capped ETF (NYSEArca: ECH) decreased 9.4% and iShares MSCI Turkey ETF (NYSEArca: TUR) dipped 5.6%. In contrast, the broader iShares MSCI Emerging Markets ETF (NYSEArca: EEM) was up 0.1% over the past year.
Weighing on some emerging markets, the U.S. dollar has appreciated 12% on a trade-weighted basis between June 2014 and March 2015. [EM Currency Hedged ETF Receiving Increased Interest]
“It can give rise to negative balance sheet effects that damage emerging market growth. This is especially the case where there are substantial mismatches between the dollar liabilities and assets of corporates, banks and governments in[emerging markets],” Slater added.
For instance, the drop in resource prices have pressured commodities export-oriented emerging countries – Chile is a major exporter of copper, and Malaysia’s commodity exports make up about 8% of Gross Domestic Product. However, lower commodities prices are a positive for many other emerging economies that import raw materials. [Copper Crush Crimps Chile ETF]
Additionally, diminished capital flows due to currency risks could also weigh on the emerging markets. Since investors would pull out of foreign markets if the U.S. dollar strengthens, emerging market currencies would weaken and the local central banks could tighten rates or drain banking liquidity to help stem the flows.
For more information on the developing economies, visit our emerging markets category.
Max Chen contributed to this article.