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Expectations that the Federal Reserve will hike interest rates later this year have powered a rally in the U.S. dollar, and with further gains likely, analyst warn that some dollar-denominated emerging market (EM) debt is vulnerable.
"The dollar's appreciation has pushed up the local-currency value of EM debt that is denominated in U.S. dollars, making it harder to service," said Capital Economics' Senior Asia Economist Daniel Martin.
The dollar has soared nearly 20 percent over the past seven months against a background of loose monetary policy in many of the world's economies and expectations for tighter policy in the U.S. The U.S. dollar index, which rose nearly 5 percent in January alone, sits near twelve-year highs.
"If the pace of dollar appreciation accelerates, certain countries would become vulnerable," said Societe Generale EM sovereign debt strategist Regis Chattelier. Ukraine and Venezuela are already at risk and Turkey could join the list, he said.
"Russia and Ukraine are well off the scale, and appear most vulnerable to dollar strength," which exacerbates their dollar-denominated external debt burdens, Martin said.
Geopolitical tensions between Russia and Ukraine weighed on their economies in 2014 and continue to drag their currencies. Since last August, the Ukrainian hyrvnia has weakened by over 100 percent, while Russia's ruble weakened 90 percent, with Western sanctions and the price collapse in oil – one of Russia's main exports – adding pressure.
Ukraine's dollar-denominated external debt is around 79 percent of gross domestic product (GDP), according to Martin. Russia's dollar-denominated debt of around $38 billion is perhaps less worrying given its over $2 trillion economy, according to data from Wells Fargo. A large portion of its $600 billion in corporate debt is denominated in dollars however, raising the risk companies will fault even though the government probably won't, according to Reuters.
Markets are clearly worried, despite news of the ceasefire: the yield on Ukraine's two-year government bonds, the longest available, is at 17.5 percent, according to Thomson Reuters data; the spread on Ukraine's five-year U.S. dollar-denominated credit default swaps are quoted at around 2,500 basis points and has widened by 18.2 percent in the last month, according to Markit data.
"Russia is not as vulnerable," said SocGen's Chattelier. And the spreads on its debt reflect the weaker concerns.
The yield on Russia's government bonds is 13.84 percent for the two-year and 13.6 percent for the five-year; the spread on the five-year dollar CDS has been narrowing and is currently quoted at around 500 basis points.
Turkey, Chile and Peru are also at risk given large dollar-denominated debt burdens and currencies that have held up against dollar strength thus far, Martin said.
"Turkey is in a difficult situation. Falling oil prices help reduce its current deficit and inflation, but a further strengthening of the dollar would drive up the cost of servicing its debt," said SocGen's Chattelier.
By contrast, Brazil should be out of the danger zone as its currency already fell "a long way", Martin said. The Real has weakened by nearly 30 percent since early September.
Asia as safe haven
Asia's dollar-denominated debt is relatively safe, analysts say, as many Asian countries are exporters with high current account surpluses.
Credit-to-GDP ratios in Thailand, Malaysia and South Korea have increased recently, Martin said. In Thailand, the ratio increased by 30 percentage points to around 80 percent of GDP.
"Asia is a safer part of the EM universe," said Aberdeen Asset Management's Head of Asia Credit, Thu Ha Chow. Political and structural reforms have boosted the credibility of the sovereigns that were seen as the weaker links, such as India and Indonesia, she said.
— CNBC's Leslie Shaffer contributed to this story