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Monday, March 27, 2023

Emerging Markets Burn Through Currency Reserves as Crisis Risks Grow

Emerging Markets Burn Through Currency Reserves as Crisis Risks Grow – Emerging markets are burning through stockpiles of U.S. dollars and other foreign currency at the fastest rate since 2008, raising the risk of a wave of defaults affecting the most fragile economies in the world. According to data from the International Monetary Fund, the foreign reserves of emerging and developing countries have dropped by $379 billion so far this year through June.

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According to JPMorgan Chase & Co., emerging markets are experiencing the largest declines since 2008, excluding the effects of exchange-rate movements and the significant foreign exchange reserves of China and Gulf oil exporters. Reserves are being used by central banks all over the world to protect their currencies from the strengthening US dollar and to pay for rising import costs for food and fuel.

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With substantial foreign currency reserves, larger emerging markets like China, India, as well as Brazil are well-prepared to weather the storm, but other countries are on the verge of running out. Since Sri Lanka’s offshore bond default in May, it has been unable to import necessities like fuel and other necessities.

According to the International Air Transport Association, Nigeria is also experiencing a severe foreign currency crisis, with the central bank preventing foreign airlines from returning $464 million in an effort to save US dollars. Economists warn that Ghana, Pakistan, Egypt, and Turkey are all at risk of experiencing a currency crisis. Brad Setser, a senior fellow at the Council on Foreign Relations and a former adviser to the United States, stated that “there is an immediate risk in a few fairly significant countries.”

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These are countries that had insufficient reserves to begin with. They are using their reserves to pay for imported food and energy since they can no longer obtain finance, and if this situation persists much longer, they certainly run the prospect of a currency or debt crisis.

Investors have emphasized that they believe there is minimal likelihood of a generalized crisis, with stress being limited in a small number of countries with persistent political and economic issues, despite this year’s historic sell-off in emerging-market assets. However, pressure seems to be extending beyond those well-known weak spots.

According to data source CEIC, among them are the Czech Republic, which has depleted 15% of its reserves this year, and Hungary, where reserves have fallen by 19%. Both have been severely impacted by Russia’s invasion of Ukraine and Moscow’s squeezing of Europe’s gas supplies. This year, the value of the Hungarian currency against the dollar has dropped by around 30%.

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As a financial safety net, central banks maintain stashes of dollars, euros, Japanese yen, and other currencies. They can use those reserves to assist local businesses pay for imports or make bond payments to foreign investors, or they can sell them when they want to increase the value of their own currencies.

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