Strong dollar threatens global economy, warns BIS

The growing strength of the dollar poses a threat to the stability of emerging economies, a global financial watchdog has warned.

The Bank for International Settlements (BIS), often described as the central bankers’ bank, has warned that fragility in financial markets could have a profound impact on the global economy, especially emerging economies, such as China and India.

Its warning came as China released disappointing trade figures on Monday, and the dollar rose to a seven-year high against the yen and a five-year high against the Bloomberg Dollar Spot Index, a basket of 10 currencies.

The Switzerland-based BIS also revealed that issuance of collateralised debt obligations – the controversial securities once likened to financial weapons of mass destruction – has surpassed levels recorded before the crisis. Activity in the leveraged loans market – a type of CDO – was running at $250bn (£161bn) per quarter in the year ending September 2014, compared with an average of $190bn in 2005-07.

The data was in the BIS quarterly review, published on Sunday, which analysed recent episodes of stock market turbulence. The latest flash crash was on 15 October, when stock markets plunged in value and movements in US treasury bonds were more severe than the day Lehman Brothers collapsed.

“To my mind these events underline the fragility – dare I say growing fragility – hidden behind the markets’ buoyancy,” said Claudio Borio, head of the Bank’s monetary and economic department. “And it would be imprudent to ignore that markets did not fully stabilise by themselves,” he said – a reference to “soothing statements” from central banks that they could maintain ultra-low interest rates and bond-buying programmes aimed at boosting economic confidence.

Against this backdrop, the BIS is concerned that some emerging economies could come unstuck because of a growing dependence on loans taken out in US dollars.

Offshore lending in US dollars has hit $9tn, roughly double its 2008 value. Emerging economies have taken out $3.1tn in cross-border loans, mostly in US dollars. Since the end of 2012 alone, dollar loans to China have doubled to $1.1tn, and Chinese citizens have borrowed more than $360bn in debt securities.

But this puts borrowing economies in a vulnerable spot. As the dollar appreciates in value against the local currency, the loan becomes more expensive to repay, raising the risk of default and economic instability. The dollar has been rising against the euro and the yen since the US Federal Reserve announced an end to its stimulus programme and hinted at an interest-rate rise next year. In contrast, the European Central Bank and Bank of Japan have loosened monetary policy and signalled greater stimulus.

“The appreciation of the dollar against the backdrop of divergent monetary policies may, if persistent, have a profound impact on the global economy, in particular on [emerging market economies]. For example, it may expose financial vulnerabilities as many firms in emerging markets have large US dollar-denominated liabilities,” BIS said.

BIS is more positive about oil prices, which have fallen by 40% since June, although it points out that some oil-exporting countries, such as Russia and Brazil, will face difficulties.