Dollar Tsunami Hits Emerging Markets

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Ben Bernanke’s signaling of a possible tapering of the $85 billion-a-month stimulus the Fed has been providing the U.S. economy has had the disruptive first and second-order effects one associates with a tsunami.

The tremors in the currency markets as the dollar becomes stronger have been felt for some time now. Now there is a tidal wave of overseas stock markets plunging as investors realize that the U.S. is the place to be.

U.S. Rising

While the emerging markets have been the worst hit, the developed economies haven’t escaped the upheaval caused by Bernanke’s June 19 communication. The euro and GBP both lost 1 percent on the day, and the yen 1.5 percent. The Dollar Index that tracks the dollar against six other major currencies rose 1 percent, indicating the dollar’s consistent gains.

While the Fed has made it clear that it will not hike interest rates till unemployment falls to 6.5 percent from current levels of 7.6 percent, consumer confidence indices are at a five year high in the U.S., and home prices are continuing to rise. This could lead to a further strengthening of the dollar and investment in U.S. securities becoming more attractive.

This is good news for companies that sell primarily in the U.S. market like an AT&T (NYSE: T), Southwest Airlines (NYSE: LUV), or a Kroger (NYSE: KR). Unlike MNCs who will see the value of their foreign income and assets fall due to a rise in the dollar, such companies remain unaffected. In the case of Southwest, ironically a strong dollar allows it to expand its operations internationally (it already flies to Mexico and the Caribbean). Of late, the dollar’s rise has been accompanied by the commodity markets bottoming out. The lower input costs help a food retailer like Kroger push even more aggressively on its strategy of displacing branded items with store brands—the latter now accounting for 24 percent of all sales. AT&T potentially can make 4 cents on every dollar of debt that it uses to retire dividend paying stock in the current scenario of a rising dollar combined with low interest rates. 

Emerging Markets or Submerging Markets?

Emerging markets from Poland and Turkey in Europe, Thailand and the Philippines in Asia, to South Africa and Mexico, have all seen their currencies fall between 1 to 4 percent against the dollar in the last week.

The stock markets, the engines of growth in these rapidly growing economies, have not taken the shock well. While the Brazilian index went down by 2.5 percent, Mexico’s stock market lost 2 percent. Asian markets, with their high foreign exposure, were worst hit—the Philippines’ market lost 4.6 percent, Indonesia’s 3.5 percent, while Thailand was the worst performer with a 5 percent fall.

Money pulled out from these markets by foreign investors is going into instruments like 10-year U.S. Treasury bonds whose yields have been consistently rising since May 2013.

India— From Bad to Worse

India’s case illustrates the vulnerability of emerging markets. Until recently India was a poster child for emerging markets, clocking 8-9 percent growth rates and being talked about in the same breath as China. While China’s economy is also slowing down, India’s suffered several self-inflicted wounds due to policy paralysis and a high current account deficit.

No sooner had the news that India’s GDP growth had fallen to a 10-year low of 4.8 percent for the Jan-March quarter percolated than the dollar tsunami hit the Indian rupee. In just a week the rupee slid to a record low of 59.93, prompting the central bank to intervene and recover it to 59.57 by the day’s close. On cue, the stock market shed 526 points—the biggest fall in nearly two years.

While the dollar’s appreciation is good news for India’s $133 billion services export market, the economy’s growth is heavily import driven—the oil import bill of $160 billion is a glaring example.

A record current account deficit of $32.6 billion in the last quarter of 2012 (6.7 percent of GDP) was already a cause for alarm for India’s economic planners—the free-falling rupee has just made that a nightmare.

Indian companies with unhedged foreign currency loans are also going to feel the heat. These include blue-chips like BhartiAirtel, ACC, and Grasim Industries. The Indian economy is likely to get worse before it gets better.

The Sting in the Tail

However, there is a downside for the recovering U.S. economy—a strong dollar will hurt exports by making U.S. goods more expensive. Germany has weathered the worst of the Eurozone crises on the back of strong export performance, but U.S. exports grew by just 1.7 percent between May 2012 and April 2013. China overtook the U.S. as the world’s largest exporter in 2009, an ironic statistic when one considers that the U.S. economy at $15 trillion is more than double China’s $7.3 trillion (2011 figures).

Other markets are also feeling the effects of Bernanke’s announcement. Gold hit a two-and-a-half year low, and Brent Crude futures had their single largest drop since November 2012.

The aftershocks of this tsunami are not over yet.

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Preetam Kaushik has no position in any stocks mentioned. The Motley Fool recommends Southwest Airlines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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