18 January 2015

Strong Dollar Clouds Forecast at Davos

As the financial world’s elite gathers to discuss what’s in store for 2015’s global economy, a problem could be festering in emerging markets
Jamila Trindle is a senior reporter who covers finance, economics and business where they intersect with national security and foreign policy. Her beat spans everything from the economic underpinnings of conflict to sanctions, corruption and terror finance. Before coming to Foreign Policy magazine, Jamila reported for the Wall Street Journal’s Washington bureau, covering financial regulation and economics. She has also worked as a foreign correspondent in China, Indonesia and Turkey as a freelancer for NPR, Marketplace, The Guardian and others. She moved back to the U.S. to cover the post-crisis economy for PBS in 2009. 

Good news for the U.S. economy could turn out to be bad news for the rest of the world in 2015, a growing number of economists are warning. While the U.S. economic recovery is a boon for Americans and the countries from which they import, the dollar’s rising strength could also bring out lurking problems in less-developed countries.

Growth in the United States while other parts of the world are faltering could squeeze people in emerging markets who borrowed in dollars when times were good. Now, they have to pay back in dollars that have been bolstered in value as their own local currencies have plunged.

That’s one of several looming economic clouds likely to follow world leaders, top economists, titans of business, and other 1-percenters as they helicopter into the annual World Economic Forum in secluded Davos, Switzerland. European growth is stagnant, and Greece is again flirting with exiting the European Union, while falling oil prices are proving a boost for some countries and a liability for others.

The United States is the one bright spot: Unemployment is down, consumer spending is up, and GDP expanded at a 5 percent annual rate in the third quarter of 2014, the biggest jump since 2003. But for emerging markets, which attracted a lot of investment while the United State was in the doldrums, the upturn stateside could signal rough times ahead.

While American growth can lead to a pickup in countries that export to the United States, the World Bank this week said it’s not enough to keep the rest of the global economy expanding. The bank tempered expectations for worldwide growth in 2015, lowering its forecast to 3 percent from 3.4 percent. It also lowered the growth outlook for emerging markets to 4.8 percent, as well as lowered the outlook for China, Brazil, and Russia individually.

Although the overall growth picture isn’t dire, some economists are worried that improving fortunes in the United States and slowing growth in emerging markets could create a mismatch: Foreign businesses that borrowed in dollars will have a hard time paying the money back.

While U.S. interest rates have been at historic lows since the 2008 financial crisis, many foreign companies borrowed in dollars. They sold bonds on U.S. and European markets and must now pay back bondholders in either dollars or euros — even though their own currencies are far weaker by comparison. That means it takes more Indonesian rupiahs, South African rands, and Brazilian reals to satisfy dollar payments.

And the dollar is only expected to get stronger. Marc Chandler, global head of currency strategy at Brown Brothers Harriman, says the dollar’s value is still in the early days of appreciation.

“There’s a combination of good things happening in the U.S. and bad things happening elsewhere,” Chandler said over the phone. He said “that’s when the pressure comes” for emerging-market borrowers.

Economists looking out for the next potential crisis flagged this issue in December. The Bank for International Settlements (BIS) in Basel, Switzerland, represents the world’s largest central banks. Not only is emerging-market corporate borrowing a potential flash point, BIS said in its quarterly report, but it’s hard to know exactly how much dollar debt is out there because nonfinancial firms aren’t tracked as closely as banks.

What is clear is that more and more borrowing is crossing national borders, and borrowers in developing countries are taking on more debt than before. Emerging-market companies, other than banks, issued $554 billion in international bonds between 2009 and 2013, according to BIS. Almost half that amount was issued by companies’ affiliates overseas, which means those bonds may be tallied as debts in London or New York instead of in the companies’ home countries.

Stephen Cecchetti, an economics professor at Brandeis International Business School and a former BIS economist, says the lack of clear data means it’s not yet time to worry.

“Would we be better off if the U.S. were not recovering?” asked Cecchetti. “Is the world better off with high growth or low growth? I think they’re better off with high growth.”

Although it might not lead to systemic crisis, big emerging-market firms not being able to make good on their debts could embroil their local governments in messy bailouts. In December, Russia demonstrated how doing so cansnowball when the country moved to help state-owned oil giant Rosneft, one of the world’s largest oil companies and also one of the most indebted.

Rosneft had bond payments due at the end of the year in dollars, but couldn’t pay them back because the Russian ruble plunged 50 percent last year. Rosneft looked to the Russian government for help, and the country’s central bank arranged a backdoor sweetheart deal allowing the company to borrowmoney from local banks at a better rate than the government itself can borrow at.

That got Rosneft out of a fix, but it spooked global investors. Now they worry that Putin will do anything to back state-owned companies run by his wealthy cronies.

Moscow’s debt problems are uniquely exacerbated by Western restrictions intended to keep Russian firms from borrowing in international markets. The United States and European Union slapped sanctions on many of Russia’s big state-owned companies after Moscow annexed Crimea and sent troops into eastern Ukraine.

But many countries have been hurt by trying to help flailing local firms, even without being hamstrung by sanctions. During the 1997 Asian financial crisis, for example, currencies plummeting as much as 50 percent against the dollar made it hard for countries like Thailand and South Korea to pay back loans in dollars.

While most economists aren’t predicting a repeat of the Asian financial crisis, corporate defaults in emerging-market countries could scare off investors who are already heading for the exits. The downturn in the U.S. economy after the 2008 financial crisis spurred an investment spike for smaller economies with more potential for growth. As the American economy has recovered over the past year, many investors have migrated back to safer U.S. assets. Concerns about financial stability would lessen investors’ already waning interest.

“I think that the love affair with emerging markets is over,” said Chandler. “Emerging markets had a good cycle. And that cycle is over.”

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