Exchange rate movements increase the vulnerability of firms from emerging market economies, including India, which have used the proceeds of dollar bond to fund financial assets, says a report.
Foreign currency borrowing helps emerging market economies to tap diverse funding sources. However, in case of currency depreciation, there are “adverse balance sheet valuation effects” on borrowers, the Bank for International Settlements (BIS) in a report.
It further noted that the dollar bond issuance by emerging market firms are similar to trade-like transactions that leave them vulnerable in an “environment of dollar strength”.
The findings of the report come at a time when the domestic currency is witnessing a rough period amid soaring interest rates in the US and rising crude oil prices. The local unit is, currently, hovering around 73 per US dollar.
The MSCI Emerging Market Index dropped by about 35 per cent from mid 2014 to January-end 2016, indicating a period of financial turbulence for emerging market economies firms.
This was a period when the US dollar strengthened against emerging market currencies, putting strains on firms that had borrowed in dollars during the earlier period when dollar credit was more accommodative.
According to the latest BIS estimate, the total stock of US dollar-denominated debt of non-banks outside the US stood at $11.4 trillion, of which non-banks from emerging market economies accounted for $3.7 trillion.
“Exchange rate movements precipitate vulnerabilities of emerging market economies’ firms who have used the proceeds of dollar bond issuance to fund financial assets, including cash in local currency,” the report said.