Strong dollar, weak oil and emerging markets growth
Many emerging economies have been banking on weaker currencies to revitalise economic growth. Oil’s 25 percent fall in dollar terms this year should also help. The problem however is the dollar’s strength which is leading to a general tightening of monetary conditions worldwide, more so in countries where central banks are intervening to prevent their currencies from falling too much.
Michael Howell, managing director of the CrossBorder Capital consultancy estimates the negative effect of the stronger dollar on global liquidity (in simple terms, the amount of capital available for investment and spending) outweighs the positives from falling oil prices by a ratio of 10 to 1. Not only does it raise funding costs for non-U.S. banks and companies, it also usually forces other central banks to keep monetary policy tight, especially in countries with high inflation or external debt levels. Howell says:
If you get a strong dollar and intervention by EM cbanks what it means is monetary tightening…The big decision is: do they allow currencies to devalue or do they defend them? But when they use reserves to protect their currencies, there is an implicit policy tightening.
The tightening happens because central bank dollar sales tend to suck out supply of the local currency from markets, tightening liquidity. That effectively drives up the cost of money, as banks and companies scramble for cash to meet their daily commitments. Central banks can of course offset interventions via so-called sterilisations – for instance when they buy dollars to curb their currencies’ strength, they can issue bonds to suck up the excess cash from the market. To ease the tight money supply problem they can in theory print more cash to supply banks. But while many emerging central banks did sterilise interventions in the post-crisis years when their currencies were appreciating, they are less likely to do so when they are trying to stem depreciation, says UBS strategist Manik Narain. So what is happening is that (according to Narain):
Markets are forcing central banks into supporting growth or the currency. You absolutely have to sacrifice growth as we have seen in places like Turkey where liquidity has impacted the growth profile
The silver lining could yet be oil.
Despite a clear economic recovery in the United States, real wages remain below pre-crisis levels, meaning the U.S. consumer has so far been reluctant to open his wallet too wide. So developing countries have been unable to significantly boost exports of goods and services. The falling oil price could change that as it will improve household budgets in the United States hugely – one study from Citi estimates the global windfall so far at $660 billion, which includes a $600 per-household bonus in the United States. A separate study from Deutsche Bank says every one-cent drop in oil prices means a $1 billion annual decline in energy spending by Americans.
That cash may be used on consumer goods, including those imported from the developing world. Some fund managers are betting on that to happen