IMF warns dollar could weigh on US growth

Washington: Further gains in the dollar could leave US growth “significantly debilitated” and have repercussions across emerging markets, the International Monetary Fund has warned.

In a health check on the US, the Fund reiterated its advice that the Federal Reserve should hold off raising interest rates until next year, in part because of the risk that it triggers a new rise in the dollar with destabilising consequences globally.

Continued appreciation of the dollar, which has risen more than 20 per cent against a basket of key currencies in the past 12 months, is a “prominent risk” because of growth divergences between the US and other economies, the IMF added, as it forecast a steady widening of the current account deficit towards 3.5 per cent of GDP over the rest of decade.

Janet Yellen, the Fed chair, has pledged that rate rises from current near-zero levels will be gradual as she attempts to prevent a sharp lurch in yields and the dollar when a move finally happens.

Rapid dollar appreciation helped torpedo the chances of a Fed interest rate increase in March, as the high currency restricted exports and dragged on growth in the first quarter.

Official figures on Tuesday morning showed the US trade balance is continuing to bear the influence of the high currency, as it widened to $41.9bn in May from $40.7bn the prior month. The dollar index rose another 1 per cent on Tuesday morning amid that Greece may leave the Eurozone.

The Fed’s plans will have huge ramifications worldwide. Central banks and finance ministries around the world are braced for possible capital outflows and currency gyrations as investors funnel money into higher-yielding US assets following a US rate rise.

The IMF said the Fed had “carefully prepared and telegraphed” its intentions to raise rates. But the move could still trigger a “significant and abrupt rebalancing of international portfolios”, accompanied with market volatility and damage to financial stability around the world.

“A shift in expectations about the future pace of rate increases could create flows into US dollar assets and a further meaningful appreciation of the dollar,” it added.

The Fund found that the dollar is already moderately overvalued. If the currency were to rise towards a “substantial” overvaluation, widening the current account deficit toward 5 per cent of GPD, “this would likely point to the move in the dollar having gone ‘too far’, potentially creating future risks, including in some emerging market economies, as global imbalances reassert themselves,” the Fund said.

The IMF analysis came in its detailed ‘Article IV’ report on the US economy, in which it gave a cautiously optimistic overview of the domestic economy. “A solid labour market, accommodative financial conditions, and cheaper oil should support a more dynamic path for the remainder of the year,” the report found. The IMF predicted an acceleration in gross domestic product growth from 2.5 per cent this year to 3 per cent next.

Potential growth at around 2 per cent will be “considerably weaker” than before the financial crisis, however, unless the US pushes through reforms to lift its dismal productivity performance, incentivises innovation and investment and boosts labour force participation, the report found.

The Fund warned against a repeat of “down-to-the-wire brinkmanship” in negotiations over fiscal policy and the debt ceiling later this year, saying this could damage confidence — particularly if the timing coincided with a Fed rate rise.

Asked about the possible restructuring of the Puerto Rico’s $72bn debt mountain, Nigel Chalk, the IMF’s US mission chief, said the lack of a strong and consistent legal framework was a problem for the US territory given the need for at least some reprofiling of the debt.

“It is generally viewed that the institutional and legal framework for Puerto Rico to undertake any kind of workout process with its creditors is made much more difficult by the fact there is no real legal framework like Chapter 9, particularly for some of the government agencies” he said.

The island cannot seek Chapter 9 bankruptcy protection as Detroit did, and since it is not a sovereign country, it cannot ask the IMF for help or loans to tide it over while it restructures its debts. The Obama administration has encouraged Congress to take a “close look” at Puerto Rico’s inability to seek Chapter 9 bankruptcy protection, something only the legislature can change.

— Financial Times