Published On: Wed, Mar 1st, 2017

Moody’s: Trump border tax could hit LatAm via currency shift

us-dollars-2The proposed 20% US border adjustment tax, could spur a rapid valuation of the dollar – as high as 25%, generating vulnerabilities for dollar-dominated economies across Latin America and the Caribbean (LAC) in addition to the trade and political fallout from such a maneuver, according to an impact report from Moody's.

"Even a partial dollar appreciation could be very large compared to historical movements in the dollar, and pose significant but varied risks for other countries," said Elena Duggar, an associate managing director in a press release from Moody's.

The report "Global Macro Risks - Sovereigns: Stronger US Dollar and Potential Change in US Imports Create Vulnerabilities for Some Sovereigns," analyzes the potential macroeconomic impacts of a border tax and the transmission channels through which a stronger dollar would impact sovereigns.

"The size of dollar appreciation and the time frame over which adjustment takes place are uncertain, even though in theory the proposed 20% border tax could result in an immediate and permanent nominal appreciation of the dollar by 25%," says Moody's senior analyst Madhavi Bokil.

Building out three distinct scenarios for a BAT roll-out, the report said that the magnitude of the appreciation and the timeframe for an adjustment to take place would depend on the responsiveness of foreign currency markets to changes in US trade policies and transmission mechanisms through the US economy.

"In practice, an assessment of the impact is complicated by the asymmetric impact the border tax would have on different industries," Bokil noted.

Moody's asserted in the release that if the US dollar was to significantly appreciate, "sovereigns with high levels of US dollar-denominated debt relative to domestic output would be highly vulnerable and experience an increased burden in servicing their dollar denominated debt. Owing to the prevalence of the dollar, the vast majority of the almost US$1.8tn foreign currency sovereign debt globally, as of 2015, is denominated in US dollars."

In the LAC region, this would be particularly relevant for Jamaica, with its high ratio of currency debt to GDP, dollarized economies that include Ecuador, El Salvador and Panama; as well as nations with currencies closely tied to the dollar (the Bahamas, Aruba, Antigua and Barbuda, Curacao, Dominica, Barbados, Belize, Venezuela, Guyana, Suriname, Nicaragua, Honduras).

"All of these countries would face tighter monetary conditions and loss of competitiveness, and the need for internal adjustment if they were to maintain their pegs," read the report.

Other nations impacted would be those with de facto exchange rate anchors to the US dollar, including Argentina, Bolivia, Dominican Republic and Guatemala.

Under the three scenarios proposed by Moody's, the agency deems as most probable a long-term, partial-nominal exchange rate adjustment as most likely, while acknowledging it lacks the historical data to have confidence.

That would see the dollar strengthen 0-25% in value with no impact on US real output or its trade deficit, while increasing prices. In this outcome, there would be relatively little changes in trade for most nations and higher US prices.

Another outcome, which accounts for the unusual pro-export, anti-import BAT's effectiveness as a possibility with a gradual or partial appreciation of the dollar (varying sector-by-sector), the US could lower its trade deficit and increase exports at the cost of much higher prices.

At any rate, Mexico, which already saw the peso lose 14% in 2016 on lower oil prices would stand to endure a further plummet in reaction to the BAT, as well as intensification of any impacts on trade, as more than 80% of the nation's exports are directed toward the US.

Mexican economy minister Ildefonso Guajardo has been keen in recent discussions with the media that Mexico is willing and ready to walk away from NAFTA renegotiations should the US cross certain lines in an attempt force protectionist policies onto the nation.

Recently, commenting in an interview reported in local news outlet El Financiero, where the official said Mexico would "get up from the table" if the US says they are moving forward on the BAT.

Scrapping NAFTA would have Mexico, the US and Canada fall back onto existing rules under WTO membership, which could still be favorable for several industrial sectors.

Moody's stressed that the WTO may indeed play a major role in determining the outcome of a US BAT on a global level.

"Even if exchange rate adjustment mitigated the impact of the US border adjustment tax, it could be perceived by US trade partners as protectionist. Pressure could build up in other countries to retaliate and pursue their own protectionist policies," read the report. "Also, countries could pursue arbitration by the WTO. Legal and trade experts have differing opinions on whether the WTO would consider the border adjustment tax as non-discriminatory, similar to a VAT."

"Escalating retaliatory actions, especially in the event that the WTO concludes that the border tax does not comply with WTO rules, could potentially spiral into trade wars."

Moody's stressed that the lack of precedence for the US proposal and complexity of current global trade dynamics make the impact of retaliatory actions uncertain, adding, "A meaningful decline in global trade flows cannot be ruled out."

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