IMF says dollar's rise hit emerging markets harder than advanced economies
Business
A 10pc appreciation means 1.9pc cut in emerging market economies’ GDP after a year
WASHINGTON (Reuters/Web Desk) – Emerging market economies bore the brunt of the strongest US dollar in two decades in 2022, a rise that battered them with capital outflows, higher import prices and tighter financial conditions, the International Monetary Fund said on Wednesday.
The IMF said new research in its annual External Sector Report shows that the dollar's surge last year had a bigger impact on emerging markets than on smaller advanced economies, partly due to the latter group's more flexible exchange rates.
For every 10 per cent of US dollar appreciation linked to global financial market forces, emerging market economies faced a gross domestic product (GDP) output decline of 1.9pc after one year, a drag that is expected to linger for 2.5 years, the IMF said.
The same research showed the impact was far lower in advanced economies, with output reduction peaking at 0.6pc after one quarter and the effects largely gone within a year.
The IMF said in the report that the dollar's real effective exchange rate rose by 8.3pc in 2022 to its strongest level in two decades, amid a rapid series of Federal Reserve rate increases to curb inflation and higher global commodity prices driven by Russia's invasion of Ukraine.
"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.
Many emerging market economies suffered worsening credit availability, diminished capital inflows, tighter monetary policy, and bigger stock market declines.
In advanced economies, more flexible exchange rates were able to absorb some of the impact through depreciation, while more accommodative monetary policy also helped - provided that there were firmly anchored inflation expectations, the IMF said.
"More anchored inflation expectations help by allowing more freedom in the response of monetary policy. After a depreciation, a country can run a looser monetary policy if expectations are anchored. The result is a shallower initial decline in real output," the report's authors said in a blog posting.
"In turn, emerging market economies with more flexible exchange rate regimes tend to enjoy a faster economic recovery owing to a sizable immediate exchange rate depreciation."
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.
The External Sector Report showed IMF staff assessed that the dollar was over-valued in 2022 by 3.5pc to 14.6pc, with a midpoint of 9pc. As of April 2022, the IMF said the dollar's value was 0.5pc below its 2022 average.
The Fund also said that the euro was over-valued in some Eurozone countries, by about 10pc in Italy and Finland, while it was undervalued in others, by 8pc in Germany.
What does it mean to developing countries like Pakistan?
Meanwhile, this acknowledgment by the IMF, which itself has been pressing the countries like Pakistan to stop interfering with the exchange rate but won’t accept the contradiction in its stance, is actually an endorsement of what Finance Minister Ishaq Dar has been saying for years – a staunch advocate of a strong national currency and opponent of devaluation.
As the IMF negates its own panacea recommended to different countries under the headline that that the market should determine the exchange rate sans any interference by the government, it provides an opportunity to Dar’s critics who consider him a complete failure.
Brazilian President Luiz Inácio Lula da Silva is perhaps most known critic of the dollar dominance and has recently again forward a proposal to establish a common currency for the Mercosur trade bloc, comprising Argentina, Brazil, Paraguay, and Uruguay.
