20-7-2023 (NEW YORK) The International Monetary Fund (IMF) revealed on Wednesday that the strengthening of the U.S. dollar, primarily driven by global financial risks in the previous year, had harsher negative effects on emerging market economies compared to developed economies.
According to the IMF’s annual External Sector Report, the real effective exchange rate of the dollar surged by 8.3 percent in 2022, reaching its highest level in two decades. This appreciation came amidst a series of Federal Reserve interest rate hikes aimed at curbing inflation and higher global commodity prices triggered by the Ukraine conflict.
The spillover effects from the dollar’s appreciation had a disproportionate impact on emerging markets, while the repercussions on advanced economies were relatively minor and short-lived, the IMF stated.
For emerging market economies, a 10 percent increase in the value of the dollar, influenced by global financial market forces, resulted in a 1.9 percent decline in gross domestic product (GDP) output after one year. The adverse effects were expected to persist for two and a half years, according to the IMF’s analysis.
In contrast, the negative consequences for advanced economies were significantly smaller, with a peak output reduction of 0.6 percent after one quarter, and these effects largely dissipated within a year.
Furthermore, many emerging market economies experienced worsened credit availability, reduced capital inflows, tighter monetary policies, and significant stock market declines due to the dollar’s appreciation, the IMF revealed.
The IMF report also highlighted that the appreciation of the dollar had a noticeable impact on global economic growth, as evidenced by changes in global current account balances, a key metric in calculating the sum of absolute current account balances across countries.
The IMF’s assessment indicated that a 10 percent appreciation of the dollar corresponded to a decline in global current account balances by 0.4 percent of world GDP after one year. Such a magnitude of decline was considered “economically significant” by the IMF, given that average global balances over the past two decades stood at approximately 3.5 percent of world GDP, with a standard deviation of 0.7 percent.
The decline in global balances was attributed to a broad-based contraction in trade, facilitated by dominant currency pricing and narrowing commodity trade balances due to falling commodity prices historically associated with dollar appreciations.
To mitigate the negative spillovers to emerging markets, the IMF recommended that these countries adopt more flexible exchange rates and anchor inflation expectations. Developing domestic financial markets that reduce sensitivity to exchange rates and enhancing fiscal and monetary frameworks, including central bank independence, were suggested as measures to achieve these objectives.
For emerging market economies facing severe financial frictions and balance sheet vulnerabilities, the IMF proposed implementing macroprudential and capital flow management measures to help alleviate negative cross-border spillovers.
