“Further dollar appreciation and tighter global financial conditions are likely to discourage capital flows to EMs. The rise in foreign-currency EM debt in recent years exacerbates the impact of a rising dollar on the availability and cost of financing for EMs. The direction of the dollar is critical for EMs and is inversely correlated with EM sovereign ratings,” according to Fitch.
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Some emerging markets have boosted interest rates this year, but more monetary tightening could be required before those efforts bear fruit in terms of shoring up weak currencies. However, higher interest rates in the developing world carry another set of risks.
“For example, interest rate rises may help contain pressure on EM currencies, but monetary tightening from a relatively loose starting point is another barrier to growth,” said Fitch. “And while many EM central banks typically say that they only intervene in currency markets to smooth volatility, data suggests that they may spend reserves to prevent even greater depreciation, depleting external buffers.”
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