U.S. rate hikes could hurt highly dollarized emerging market banks – Moody’s

U.S. dollar banknotes are seen in this November 7, 2016 illustration. REUTERS/Dado Ruvic/Illustration

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  • Uruguay has high dollarization at 74% of deposits
  • In Europe, Belarus, Azerbaijan and Turkey top the list
  • The Prospect of a US Rate Hike Signals Currency Volatility Ahead

NEW YORK, Feb 7 (Reuters) – Banks in Latin America and emerging Europe are the most exposed to dollarization among developing economies, making them vulnerable to weakening local currencies and rising withdrawals in the face of tightening US monetary policy, Moody’s said on Monday.

Interest rate hikes by the U.S. Federal Reserve are expected to slow capital flows to emerging markets, weaken countries’ currencies and economic growth, and potentially trigger credit risk for highly dollarized banks, Moody’s said.

“Banks with large volumes of foreign currency loans and deposits on their balance sheets are vulnerable to increased credit losses and pressure on their profitability and liquidity when the value of the local currency drops sharply,” they said. writes Moody’s analysts.

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“It becomes more difficult for unhedged borrowers to repay foreign currency loans, and depositors are inclined to withdraw funds. High dollarization also threatens financial stability in times of crisis if central banks do not have foreign currency reserves sufficient to bail out banks that are short of dollars.”

Foreign currency deposits in the national banking system of emerging countries

Moody’s found that dollar deposits are highest in banks in Latin America, emerging Europe and former Soviet countries, although relatively low in Asia-Pacific and moderate in Africa. Higher exposure to the Gulf States is offset by substantial foreign exchange reserves.

The steady depreciation of the local peso and Uruguay’s high inflation propelled the country to the top of Moody’s list of dollarized countries with 74% of deposits – a trend that is here to stay. Savings by non-residents, mainly neighboring Argentina where inflation is expected to reach 55% by the end of the year, will remain high at 10%.

Turkey, another developing economy that has seen its people grapple with high inflation and a weak currency, will see dollar deposits increase to 65% by the end of 2022, from 47% in 2020 and 63% l ‘last year.

“Retail depositors continue to convert a significant portion of their local currency deposits into foreign currencies (primarily US dollars) to protect their savings from depreciation and inflation,” Moody’s said.

Foreign currency deposits fell sharply in Argentina from 40% in 2019 to 16% in 2021 due to an erosion of confidence after the 2019 elections.

“There is a possibility of further outflows of dollar deposits if confidence in public policy or the central bank deteriorates further,” Moody’s said, noting that the central bank had little or no foreign currency reserves. to support banks in the event of a crisis.

Downward dollarization trends will continue in the near term in Azerbaijan, Armenia, Kazakhstan, Peru, and Ukraine. But banks in Azerbaijan, Armenia and Belarus are also the most exposed to uncovered borrowers, having no income in the foreign currency of the loan.

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Reporting by Rodrigo Campos; Editing by Leslie Adler

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