ANALYSIS-Emerging markets need more than Fed repos to fix dollar malaise


By Karin Strohecker and Sujata Rao

LONDON, April 2 (Reuters) - The U.S. Federal Reserve's offer of overnight dollar loans is a welcome lifeline for dozens of central banks in developing countries, but without a tangible improvement in investment and trade flows, the outlook for their currencies will remain glum.

Starting April 6, the Fed will allow foreign central banks to exchange Treasury securities for overnight dollar loans, giving them access to cash and further easing strains in global funding markets.

The move will allow countries that lack standing swap lines with the Fed to get their hands on dollars if they need to support their currencies, without having to sell U.S. Treasuries -- often the most liquid part of their reserve holdings.

But there is little sign emerging markets' currency pain is about to ease -- if anything the crisis and the Fed's efforts to ensure the flow of dollars has again laid bare the dependence of poorer nations on external capital and trade to keep afloat.

Most of their currencies still languish near multi-year or record lows and option market gauges of expected price swings still point to brutal volatility for the Brazilian real, Indian rupee and others BRL1MO=FN, INR1MO=FN.

"It could maybe reduce the strain a little bit but in general we have been already reminded again of just how high that stress level in emerging markets is," said Commerzbank emerging markets analyst Antje Praefcke.

"On top of that, the repo facility is by no means a magic bullet because it very much depends on the situation of the individual central bank -- not every one of these central banks will be in a position to tap this."

The programme is open to central banks holding a so-called FIMA account with the New York Fed which has over 200 such accounts on its books. It will last at least six months and while loans are meant to be for a day, they can be "rolled over as needed", the Fed said.

The repo move came less than a week after FX swap lines, already in place for many developed economies, were extended to nine more central banks, including emerging markets Brazil, Mexico, Singapore and South Korea.

But these temporary measures may not go far in filling emerging markets' coronavirus-linked financing deficit this year, estimated by a United Nations report at a "conservative" $2-$3 trillion.


To some extent, funding pressures triggered by the coronavirus hit developed and developing countries alike through the medium of the dollar, the currency most widely used in international transactions. Dollar borrowing costs have spiked to levels seen last in 2007-2008, during the global financial crisis, even for European and Japanese buyers.

But specific factors undermine emerging currencies during crises such as the current pandemic, leaving governments flailing for dollars to pay for crucial imports.

First, a collapse in trade and commodity prices has shrunk dollar supply. This comes after years of a widening dollar funding gap -- the difference between non-U.S. banks' dollar assets and their liabilities -- which exceeded $1.4 trillion in 2019, according to the International Monetary Fund.

Much capital invested in developing countries is from overseas and doesn't stick around when disaster hits -- a record $83.3 billion fled last month from emerging stocks and bonds, the Institute of International Finance said this week.

Finally, there is usually little fiscal room to spend more and ease the pain. Currency depreciation makes it costlier to service overseas debt which by end-2018 amounted to 35% of GDP without counting China, the World Bank estimates.

But within the developing world too there is a divide between the haves and have-nots -- those benefiting from U.S. swap lines and Treasury holdings they can offer as collateral for repos, and those who have neither.

"The central banks who can benefit the most in this regard are naturally those who already have large FX reserves and U.S. Treasury holdings," said JPMorgan strategist Jahangir Aziz.

These would include big countries such as China, India, Brazil, Korea and Taiwan.

Aziz said the repo facility was not a game-changer for countries facing currency pressures because unlike swaps it would not add to central bank reserves, boosting their intervention firepower.

But developing economies' longer-term problems cannot be resolved by the Fed, whose aim is predominantly to prevent a fire-sale of Treasuries should currency selloffs turn extreme.

Analysts at Brown Brothers Harriman noted that weekly Fed custody data showed foreign central banks sold over $100 billion of Treasuries in the three weeks to March 25 -- the time the market saw seizing up occur when too many investors rushed to sell their holdings to raise cash.

"The U.S. is not looking out for the global economy as much as for its own markets," said Stephen Gallo at BMO. "It just doesn't want a situation where the shortage of dollars feeds back into its own dollar funding markets."

Risk reversals for EM currencies

U.S Treasuries in EM FX Reserves

Shipping rates indicate trade slump IMAGE

(Reporting by Karin Strohecker and Sujata Rao in London; Editing by Catherine Evans)

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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