A strong US dollar has major implications for global economies, especially for Nigeria and other countries in Sub-Saharan Africa, the International Monetary Fund (IMF), has said.
According to the Fund in its External Sector Report, the effect is larger and more persistent for emerging market economies.
It noted that the effects of a strong dollar spread via trade and financial channels with real trade volumes in emerging economies declining more sharply, with imports dropping twice as much as exports.
“Emerging market economies also tend to suffer disproportionately across other key metrics: worsening credit availability, diminished capital inflows, tighter monetary policy on impact, and bigger stock-market declines,” the Fund said.
The implication, the Bretton Woods Institute notes, is that an appreciation of the US dollar impacts the current account of the countries.
The current account captures the change in saving-investment balances of countries. As a share of gross domestic product, current account balances (saving minus investment) increase in both emerging market economies and smaller advanced economies, because of a depressed investment rate (there is no clear systematic response for saving).
The report notes that while “exchange rate depreciation and accommodative monetary policy facilitate the external sector adjustment for advanced economies, in emerging market economies, the fears of letting the exchange rate fluctuate and lack of monetary policy accommodation magnify the increase in the current account.
“The external sector adjustment in emerging market economies is further hindered by their heightened exposure to the US dollar through trade invoicing and liability denomination.”
To navigate the effect of a strong dollar, emerging market economies must come up with policies that anchor inflation expectations or more flexible exchange rate regimes.
“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. In turn, emerging market economies with more flexible exchange rate regimes tend to enjoy a faster economic recovery owing to a sizeable immediate exchange rate depreciation.
“Flexible exchange rate regimes can be supported and facilitated by domestic financial market development that helps lessen the sensitivity of domestic borrowing conditions to the exchange rate. Sustained longer-term commitments to improving fiscal and monetary frameworks help anchor inflation expectations.
This includes ensuring a well-balanced mix of fiscal and monetary policies, enhancing central bank independence, and continuing to strengthen the effectiveness of communications,” the Fund said.
For the IMF, policymakers should go beyond using precautionary policy tools, such as global safety nets, which are important in addressing global financial market cycles and their spillovers.
“In emerging market economies with severe financial frictions and balance sheet vulnerabilities, macro-prudential and capital flow management measures could help mitigate negative cross-border spillovers,” the report said.
