The 40-year record high of US dollar against some major currencies is ringing alarm bells for another currency crisis. The ongoing situation could also trigger for another round of crash in the emerging markets. The world is more integrated now than in those days of 1980s and 1990s that witnessed major currency crisis.
Hence, the 12% surge in the US dollar since mid-2014 could pose a major challenge for emerging markets currencies.
Southeast Asian currencies are already worst hit. Brazil's currency, the real, was also hit by a 12-year low against US dollar. Mexico and South African currencies too reached their lowest levels against the US dollar.
History shows that whenever the US dollar gained, it resulted in some sort of major crisis for other economies. For instance, the dollar rally in 1980s resulted in debt crisis in Latin America while Southeast Asian economies suffered major currency crisis during 1990s owing to dollar surge.
Market analysts cite three reasons for a possible crash in emerging markets. The rise of US dollar, possible hike in interest rates by Federal Reserve and the slowdown in Commodities markets could pose a major challenge to the emerging markets. The commodities segment is considered to be the engine for emerging markets.
Business firms and industrial units in emerging markets have their liabilities in US dollar terms. Hence, the depreciation of local currency in the emerging economies against the US dollar will reduce the credit worthiness of many businesses and increase the debt repayment burden as well.
As a result, the rise in cost of debt will hamper the profitability and performance of business firms and several industry verticals.
Despite dollar's rise, the slowdown in Chinese economy is impacting the commodities market as it's suffering from the diminishing levels of demand. Brazil is suffering from a recession and Greece is still in deep trouble. All these factors are indicating that the strengthening of US dollar could result in another currency crisis in emerging markets.
The possible hike in interest rates by Federal Reserve could further strengthen the dollar as the move is expected to bring in investments into the US market.
If one looks at the other side of coin, the dollar surge could also hit US growth prospects. According to New York Fed's Research and Statistics Group, "a 10% surge in the currency results in 0.5% decline of GDP growth and an additional 0.2% in the following year in case the strength of currency persists."
The US dollar rose 12% since mid 2014.
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