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US dollar appreciation hits emerging markets harder than developed economies -- IMF

Xinhua | Updated: 2023-07-20 09:13
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NEW YORK -- The US dollar appreciation driven primarily by global financial risks last year had harder negative spillovers, especially for economic activity and imports, on emerging market economies than on developed economies, the International Monetary Fund (IMF) said on Wednesday.

The IMF said in its annual External Sector Report 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, the IMF said.

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, according to the IMF.

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, the IMF said.

Many emerging market economies also suffered worsening credit availability, diminished capital inflows, tighter monetary policy on impact, and bigger stock-market declines, the IMF said.

"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.

According to the IMF's assessment, 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," the IMF said, 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, it added.

The IMF suggested that more flexible exchange rates and more anchored inflation expectations could mitigate negative spillovers to emerging markets.

The IMF recommended that emerging market countries 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, including central bank independence, 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.

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