Three ways a strong dollar impacts emerging markets

The US dollar is on a tear, strengthening around 11% since the start of the year and – for the first time in two decades – reaching parity with the Euro.  

Indeed, an overwhelming number of major currencies have depreciated against the dollar, with big implications for the developing world.

Given the slew of headlines, this articles outlines some of the key impacts that a strong dollar has on emerging markets (EMs). 

First, why is the dollar appreciating?   

The dollar is strengthening primarily because there is strong demand for dollars. 

The economic outlook for most economies points towards a major slowdown.

Meanwhile, the war in Ukraine has created massive geopolitical risk and volatility in markets. 

On top of that, historic inflation has prompted the US Federal Reserve to aggressively hike rates. 

These factors, among others, are prompting a flight to safety, wherein investors are exiting positions in Europe, EMs, and elsewhere and looking for safe harbor in US-denominated assets – which, obviously, require dollars to buy. 

This is not a new phenomenon. 

The invasion of the Ukraine has triggered an initial appreciation of the U.S. dollar against EM currencies that was larger than appreciations related to the 2013 taper tantrum and previous conflict-related events involving oil exporters. 

The market continues to expect rapid Fed rate increases. 

In similar situations of rapid rate increases in the past, EMs have faced crises.

This was the case in the 1980s in Latin America with the “Lost Decade,” and in the 1990s “Tequila” crisis in Mexico (which then extended to Russia and East Asia). 

Debt Worries 

Expect to see more stress in the sovereign debt space – which is already troubled.  

Many countries – especially the poorest – cannot borrow in their own currency in the amount or the maturities they desire. 

Lenders are unwilling to assume the risk of being paid back in these borrowers’ volatile currencies. 

Instead, these countries usually borrow in dollars, promising to repay their debts in dollars – no matter the exchange rate. 

Thus, as the dollar becomes stronger relative to other currencies, these repayments become much more expensive in terms of domestic currency. 

This is what – in public debt lingo – is called the “original sin”. 

So, who is better off? 

The share of dollar-denominated debt is relatively low among East Asian countries, and Brazil has fared pretty well in recent months. 

The latter has benefitted from the central bank’s large dollar holdings, the fact that the private sector seems to have insulated itself well against currency fluctuations, and that it is a net commodity exporter. 

Growth Concerns 

As the US Federal Reserve hikes interest rates, other central banks must raise their own rates to remain competitive and defend their currency. 

In other words, investors must be given a reason (higher returns) to invest in an EM rather than move their money into less-risky US assets.  

This presents a conundrum. 

On one hand, a central bank obviously wants to protect foreign investment in the domestic economy. 

But, on the other hand, rate hikes increase the cost of domestic borrowing and have a dampening effect on growth as well.  

The Financial Times, citing data from the Institute of International Finance, recently reported that, “foreign investors have pulled funds out of emerging markets for five straight months in the longest streak of withdrawals on record.” 

This is crucial investment capital that is flying out of EMs towards safety. 
Finally, a domestic slowdown will, in time, hit government revenues and could thus exacerbate aforementioned debt problems. 

Trade Troubles 

In the short term, a strong dollar can also weigh on trade. 

The greenback dominates international transactions. 

Firms operating in non-dollar economies use it to quote and settle trades, like oil, which are bought and sold in dollars.

In addition, many developing economies are price-takers (their policies and actions don’t impact global markets) and are largely dependent on global trade; a strong dollar can have major impacts on them, domestically, including spiking inflation. 

As the dollar strengthens imports become expensive (in domestic currency terms), thus forcing firms to reduce their investments or spend more on crucial imports. 

The long-term trade picture is rosier for some, but overall it’s an uneven picture. 

Yes, imports are more expensive amid a strong dollar, but exports are relatively cheaper for foreign buyers. 

Export-led economies may be able to benefit as increased exports boost GDP growth and foreign reserves, which helps to alleviate many of these issues.

Easing the Pain 

Unfortunately, countries have few options to address these problems in the short term. 

These issues are best dealt with pre-emptively rather than reactively. 

To prevent the next crisis, countries should act now to shore up their fiscal position and engage in sustainable borrowing.  

Even in challenging times, policymakers can find opportunities to encourage investment and spur economic growth while reducing fiscal pressures. 

For its part, the international community must do more to speed up debt restructuring. Doing so will go a long way to put countries back on a more sustainable fiscal path. 

This article first appeared here.


Digital nomads open door to new SEZ models

Incentives can be shifted to attract digital nomads in wake of global corporate minimum tax.

Even though the world has surpassed the heights of the Covid-19 pandemic, analysts predict that 25% of workers will continue working from home indefinitely. 

The closure of office buildings is bad news for special economic zones (SEZs) reliant on traditional commercial real estate. 

The past three years have come with many shocks, all of which threaten to disrupt traditional business models. 

The pandemic, the supply chain crisis, inflation, war in Ukraine, and the OECD’s 15% minimum corporate tax have all taken their toll. 

Unsurprisingly, the past six months have seen a wave of SEZs running into bankruptcies, including in Vietnam, India and the Philippines.

A very different type of SEZ has emerged to cater to so-called “digital nomads” — office workers and entrepreneurs who, thanks to the internet and trends following COVID-19, no longer need to be tied to a physical location.

Most SEZs look like industrial parks. 

Some, catering to digital nomads, look more like beachfront resorts. 

To see examples of SEZs successfully tapping into this new market, look no further than the Cayman Enterprise City or Prospera in Honduras. 

Some planned future SEZs — like Malaysia’s $1.2bn Iskandar Waterfront — are taking this strategy to an extreme.

The most savvy digital nomads practice ‘min-maxing’ — a video game term referring to the practice of using the mathematics behind games in order to win more using fewer resources. 

In the context of digital nomads, the term means maximising how far one’s income goes by deciding where to temporarily relocate. 

Typically, digital nomads attempt to min-max three key metrics: cost of living, tax rules and living standards.

If SEZs want to attract digital nomads, the first question that they must ask themselves is whether they can offer a low cost of living.

Many digital nomads work for companies that pay in strong currencies, such as the US dollar or euro. 

Their mobility gives them the ability to work from anywhere, and as a result, many choose to live in jurisdictions where their currency goes further. 

Although expensive jurisdictions such as the UAE, Singapore and Monaco have much to offer, the daily cost of living is simply too high to attract digital nomads. 

On the other hand, low-cost jurisdictions such as Thailand, Brazil and Morocco have a significant advantage.

The next metric digital nomads try to maximise is personal income tax rates.

For those who hold passports from countries that tax overseas income (such as the US or China), optimisation is possible, but significantly more complicated. 

However, many digital nomads from countries like those in the EU succeed in paying no income taxes whatsoever. 

SEZs that expect to suffer as a result of the OECD’s 15% global minimum corporate tax can instead shift their incentives to offer personal income tax incentives if they want to attract digital nomads.

Finally, what matters most in the end, is quality of life.

Regardless of how a jurisdiction optimises the cost of living or taxes, intangible quality of life factors ultimately matter more than anything else. 

Many digital nomads base their decisions on factors such as the beauty of the scenery, the quality of nightlife, the presence of services like Uber, the quality of historical monuments, and the friendliness of local people.

Targeting digital nomads comes with drawbacks. 

They tend to create service sector jobs rather than export-oriented industries. 

They also are fickle and can leave at any moment. 

Most currently operating SEZs are zoned for industrial and commercial use rather than residential use. 

Countries like Portugal now offer digital nomad visas; countries with clumsy visa policies will be left behind.

While most SEZs are probably not good destinations for digital nomads, the few that successfully cater to them will become powerhouses over the next decade. 

As the world becomes more mobile, the collective economic power of digital nomads will become increasingly prominent.

This article first appeared here.


Countries Most in Debt to China

According to World Bank data, countries heavily in debt to China are mostly in Africa, but can also be found in Central Asia, Southeast Asia & the Pacific. As the new preferred lender to low-income countries, China now holds 37% of these nations’ debt. 

The New Silk Road project, which finances the construction of port, rail and land infrastructure across the globe, has created much debt to China for participating countries. 

At the end of 2020, Pakistan, Angola, Ethiopia, Kenya & Sri Lanka held the biggest debts to China. 

The countries with the biggest debt burdens in relative terms were Djibouti and Angola, followed by the Maldives and Laos, which has just opened a debt-laden railway line to China.  

The Paris Club used to hold the majority of low-income countries’ debt before it was restructured and largely forgiven after the turn of the millennium for qualifying, developing countries. 

Whether such a process will be available for Chinese debt is unclear. 

As of 2020, China had officially lent around $170 billion to low and middle-income countries, up from $40 billion in 2010.

Chinese loans have higher interest rates than those from international institutions like the IMF or World Bank or bilateral loans from Paris Club countries, and also have shorter repayment windows.

Their setup is closer to commercial loans concerning their conditions of repayment, confidentiality as well as their objectives of funding specific infrastructure projects instead of pursuing development goals in general.

The COVID-19 pandemic has complicated the already difficult repayment of Chinese loans. According to the Financial Times, China had to renegotiate loans worth $52 billion in the last 2 years, more than 3x times the amount previously. One such case was Sri Lanka – also among China’s biggest debtors – which in May was the first Asian country in two decades to default on its debt.


Regional co‑operation is critical to overcoming the challenges and risks in building regional production networks in the AfCFTA.

Some solid insights from the latest OECD/AU study, titled: “Africa’s Development Dynamics. Regional Value Chains for a Sustainable Recovery 2022”.

Attracting lead firms and helping them to operate across borders requires strengthening both formal and informal institutions. 

Many African firms struggle to internationalise and link up with lead firms.

Regional co‑operation can help tackle multiple constraints simultaneously through cross‑border production. 

Increasing environmental risks also need addressing though.

Despite limited industrial development, the death toll from outdoor air pollution in Africa outpaced that of the world by 30% and that of China by 50% over the 2010‑19 period. 

Adopting the development model “industrialise first and clean up later” of other world

regions will have unprecedented economic costs for Africa.

… so be careful what we wish for…


Rising intra‑African trade costs impede regional production networks

As shown in the chart below, the costs of trade within Africa have increased to 2007 levels since 2012, despite a considerable decline in intra‑African tariffs. 

High trade costs are detrimental to production networks because they compound each time products cross international borders. 

High costs are due to poor transport infrastructure, non‑tariff barriers and weak trade‑related services

such as logistics, trade finance and payments. 

By some estimates, logistics costs in Africa are up to 4x higher than the world average (Plane, 2021). 

The COVID‑19 crisis further increased trade costs due to disruptions to transport, restrictive trade policies and global economic uncertainty.


Why do regional value chains matter for Africa’s recovery?

The AfCFTA offers opportunities to accelerate Africa’s productive transformation and sustainable recovery from COVID-19, but intra-African trade costs, limited competitiveness and barriers to investment limit the development of regional value chains. Furthermore, policy makers on the continent should harness emerging global trends.

Below some insights from the latest _AU & OECD’s Africa’s Development Dynamics Report, Regional Value Chains for a Sustainable Recovery, 2022.