On Wednesday, the International Monetary Fund (IMF) said that the U.S. dollar appreciation driven primarily by global financial risks last year had harder negative spillovers, especially for imports, on emerging market economies than on developed economies.
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The IMF’s External Sector Report pointed out that the dollar’s real effective exchange rate rose by 8.3 percent in 2022 to its strongest level in two decades, amid a series of Federal Reserve rate increases to curb inflation and higher global commodity prices driven by the Ukraine conflict.
The negative real sector spillovers from dollar appreciations fell disproportionately on emerging markets, while the effects on advanced economies were small and short-lived.
In emerging market economies, a 10 percent dollar appreciation, linked to global financial market forces, decreases gross domestic product (GDP) output by 1.9 percent after one year, and this drag is expected to linger for two and a half years.
In contrast, the negative effects on advanced economies are considerably smaller in size, with output reduction peaking at 0.6 percent after one quarter and are largely gone in a year.
Many emerging market economies also suffered worsening credit availability, diminished capital inflows, tighter monetary policy on impact, and bigger stock-market declines.
In emerging markets, a 10% dollar appreciation decreases economic output by 1.9% after 1 year & the drag lingers for 2½ years. The negative effects in advanced economies are smaller, peaking at 0.6% after one quarter & are largely gone in a year.@annamalai_k pic.twitter.com/jgVRUMius7
— Bjp4 Coimbatore (@bjp4kovai)
July 20, 2023
“Emerging market and developing economies with pre-existing vulnerabilities such as high inflation and misaligned external positions experienced greater depreciation pressures, while commodity-exporting economies benefited from the increase in commodity prices,” the IMF said.
The IMF report also showed that the dollar appreciation has a noticeable impact on global economic growth, reflecting in global current account balances, a key metric to calculate the sum of absolute current account balances across countries.
A 10 percent dollar appreciation is associated with a decline in global current account balances by 0.4 percent of world GDP after one year. Such a magnitude of the decline is economically significant, as average global balances over the last two decades were about 3.5 percent of world GDP, with a standard deviation of 0.7 percent.
The decline in global balances reflects a broad-based contraction in trade in the presence of dominant currency pricing, facilitated by narrowing commodity trade balances, given falling commodity prices that have historically accompanied appreciations of the dollar.
The IMF suggested that more flexible exchange rates and more anchored inflation expectations could mitigate negative spillovers to emerging markets.
It also recommended that emerging economies move toward flexible exchange rates by developing domestic financial markets that reduce the sensitivity of borrowing to the exchange rates, and commit to improving fiscal and monetary frameworks to help anchor inflation expectations.
In emerging market economies with severe financial frictions and balance sheet vulnerabilities, macroprudential and capital flow management measures could help mitigate negative cross-border spillovers, the IMF said.
