CALCULATE YOUR SIP RETURNS

Strong Dollar Impact: Pros and Cons

05 August 20225 mins read by Angel One
Strong Dollar Impact: Pros and Cons
ShareShare on 1Share on 2Share on 3Share on 4Share on 5

In a recent article, global bond guru Mohammed El Erian of Allianz pointed out the key risks of sustained dollar strength. Whether the dollar actually strengthens during 2017 will largely depend on the fiscal and monetary policies adopted by the US Government and the US Federal Reserve. The assumption at this point of time is that once Trump assumes the presidency of the United States, his focus will be on cutting individual and corporate taxes as well as investing in infrastructure. With GDP growth picking up in the US and inflation following suit, the US Fed is also likely to maintain its hawkish stance on the policy front. As rates move higher in the US, as is indicated by the US 10-year generic yields, the US Dollar is likely to get stronger during 2017. This will have 5 broad implications…

 

US companies with predominantly global operations…

 

Most of the large US corporations like General Electric, Exxon, Microsoft, Cisco, Dell and Merck derive a large chunk of their revenues from their global operations. A strong dollar is likely to weigh on the performance of these global companies. Since the Indian arm of Merck will earn revenues in INR, a stronger dollar means that they will get fewer dollars for every rupee. It is hardly surprising that the quarterly revenues of US companies are finding it hard to grow. After 5 quarters of stagnation, US companies saw revenues growing by 3% in the quarter to September and are unlikely to better that rate in the December quarter. This problem becomes more acute when one considers that global operations account for a large proportion of the revenues of US companies and a much larger proportion of their profits.

 

Emerging Market currencies come under pressure…

 

This is something we have seen in the past and could repeat in the year 2017. Interestingly, this linkage between the US$ and EMs could actually happen through the medium of China. This is how it could work! As the dollar gets stronger, we may see the People’s Bank of China (PBOC) allowing the Yuan to fluctuate in a wider range. This is tantamount to weakening the Yuan as we saw previously in September 2015. Now, since China is the largest importer of most of the commodities from all over the world, a weak Yuan will force other emerging markets to also weaken their currencies. For example, economies like Brazil, Argentina, South Africa, Turkey, Indonesia, Thailand and even Australia will be forced to weaken their currencies to stay competitive. This could trigger off a mini-currency war across emerging markets. The unfortunate part of any currency war is that there are no winners and most of the EMs may end up on the losing side in this case.

 

There could be a reversal of EM flows…

 

Risk-off flows as we popularly know it, has been visible since the last quarter of 2016. When the US rates are likely to rise and the dollar is likely to strengthen, then there is a sharp increase in demand for dollar assets. It is a dual benefit for investors as they get higher yields as well as the safety of a stable currency. The biggest casualties in such cases are the emerging markets as their currencies are the most vulnerable and therefore they see a deluge of capital outflows. In fact, there are some extreme views which even do not rule out the possibility that some EMs may even consider imposing capital controls to stem outflows. But if the dollar continues to remain strong, then 2017 could be the year when the outflows from EMs could get sharper in favour of the US.

 

On the positive side, other developed economies may benefit…

 

When the dollar becomes stronger, US exports tend to get negatively impacted as their foreign currency earnings return less in dollar terms. However, on the other hand, the strong dollar will be positive for imports into the US. American consumers will find it much cheaper to import a whole range of products ranging from Japanese cars to French perfumes to Italian clothing and Australian wine. As the dollar gets stronger, all these products get much cheaper for American consumers. The big positive for other countries that are major exporters to the US is that it expands the appetite and demand coming from the US consumer. Indian IT and pharma companies will also logically benefit but they need to get over their visa worries and their Form 483 challenges for the time being.

 

Beware of the mountain of dollar debt…

 

This could be a major worry for many global companies. Global non-government debt that is denominated in US dollars is as high as $9 trillion. The last 1 year alone saw an increase of ½ a trillion dollars to the overall dollar debt. A strong dollar means that you need to pay more in local currencies for servicing interest and principal on your dollar loans. With a total mountain of $9 trillion of dollar debt, every basis point change in the dollar exchange rate can drive many global companies to the verge of default. This could be the one big risk in 2017 as far as global dollar borrowers are concerned.

 

At this point it is hard to say what will be the full impact on the US dollar as it will largely predicate on the way US monetary and fiscal policy shapes up. But, a strong dollar will surely pose interesting scenarios for the world in general and emerging markets like in India in particular.

We're Live on WhatsApp! Join our channel for market insights & updates

Enjoy Zero Brokerage on Equity Delivery
4.4 Cr+DOWNLOADS
Enjoy Zero Brokerage on Equity Delivery

Get the link to download the App

Send App Link
Get it on Google PlayDownload on the App Store
Open Free Demat Account!
Enjoy ₹0 Account Opening Charges