What does a stronger U.S. dollar mean for developing countries?

The U.S. dollar has reached historic high levels not seen for two decades, as the United States Federal Reserve has been increasing its interest rates aggressively since March 2022 amid stubbornly high inflation. Higher interest rates and the relative stability of the United States economy have boosted the dollar’s appeal and triggered a ‘flight to safety’ in the international capital market.

For developing countries, rising interest rates in the United States and the appreciation of the U.S. dollar have translated into rising debt servicing and borrowing costs and worsening fiscal and current account balances, which is undermining the prospects of their full economic recovery from the pandemic. In the long run, a strong dollar can also negatively impact economic growth in developing countries by increasing the cost of capital and reducing public and private investments.

Furthermore, a strong dollar adversely affects the price of imports, especially for developing countries that rely heavily on imports to meet domestic demand for food and energy. While a strong dollar can help to contain inflationary pressures in the United States, it has the opposite effect on inflation in net food and energy importing developing economies. In the current geopolitical context, a stronger dollar is undermining the food and energy security of many developing countries, as the import prices of food grains and oil – denominated in local currencies – have risen sharply in recent months.

The policy challenges for developing countries are even more daunting now. There is little room to maneuver given the persistent supply-side bottlenecks aggravating inflationary pressures and high levels of dollar-denominated external debt. Also, the deteriorating economic outlook for developing countries will likely further weaken their exchange rates in the near-term, exacerbating capital outflows and further worsening their financing conditions. Against this backdrop, many developing countries will face a difficult uphill battle to steer a robust recovery, stimulate growth and make progress towards achieving the SDGs.

Learn more in the October Monthly Briefing on the World Economic Situation and Prospects, available on 3 October.