The global risk of an emerging market debt crisis

Some analysts are warning that pressure on emerging markets is set to increase, after US central bank chief Jerome Powell pledged to keep raising rates and keeping them high until he be convinced that inflation was under control last Friday.

Powell’s comments pushed bond yields higher and pushed the US dollar back towards levels last seen in mid-July. The US dollar is now over 20 years against major currencies such as the euro and the yen.

The latest surge in the greenback is exacerbating the economic pressures facing many emerging markets in Asia, the Middle East and Africa, which are being forced to dip into their foreign currency reserves to cover the rising cost of importing food and fuel.

Since the prices of many commodities are denominated in US dollars, the spike in energy and fuel costs is even greater when expressed in local currencies, which have depreciated against the rise in the greenback.

To prevent their currencies from falling even further against the US dollar, many emerging markets are intervening in foreign exchange markets, using their precious foreign exchange reserves to defend their currencies.

When their currency reserves run out, emerging market central banks are then faced with the unpleasant option of raising interest rates to defend their currencies.

But while higher rates provide temporary support for exchange rates, they act as an additional drag on economic activity at a time when emerging markets are already struggling with runaway inflation.

The rising greenback is also driving up the interest rate bill for emerging markets, as much of their borrowing is denominated in US dollars.

Debt levels in many emerging countries have risen sharply during the pandemic, as governments unveiled support measures to protect households and businesses.

But with the U.S. Federal Reserve raising interest rates at the fastest pace in decades, emerging market central banks risk plunging their economies into a deep recession if they try to keep pace with those rate hikes to defend their currencies.

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