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Time for emerging markets to BAT-ten down the hatches: BofA

Cesar Rodriguez | Bloomberg via Getty Images

Emerging market economies appear to be exposed to the border adjustment tax (BAT) policies proposed by U.S. politicians ahead of a crucial window for major tax reform, according to a team of analysts at Bank of America Merrill Lynch (BofA).

U.S. President Donald Trump has long-advocated plans to lower tax rates for U.S. businesses and Republicans in the House of Representatives have since proposed the implementation of a 20 percent levy.

The suggested BAT would likely be imposed on U.S. imports, which Republicans have argued would raise $10 billion each year for the world's largest economy to invest back into the country. However, several large retailers have criticized BAT and argue the tax on lower-cost imported items could be passed on to consumers.

Market expectations, should the tax reforms be implemented before the summer, are for the U.S. dollar to appreciate by around 15-25 percent.

"We are perplexed at how casually (the) consensus predicts a 25 percent U.S. dollar rally if a 20 percent Border Adjustment Tax (BAT) is passed," a team of analysts at BofA said in a note published Wednesday.

Mexico at risk of recession

BofA analysts cited Singapore and Turkey as among the emerging market economies most at risk should the dollar soar as a consequence of BAT. However, Mexico was found to be the most vulnerable to major tax reforms in the U.S. and could even be at risk of entering a period of recession.

The prominent reason for Mexico's vulnerability to BAT comes as a result of its trade-weight towards its North American neighbor. BofA described the amount of exports Mexico has to the U.S. compared to other emerging market economies as "literally off the chart".

Mexico's exports to the U.S. account for 27 percent of its gross domestic product (GDP) whereas China and South Korea are at 4 percent, the report said.

"A major U.S. dollar rally would have major effects on capital flows and the stock of assets and liabilities, which has been less of a focus than trade in the BAT debate," the team of analysts at Bank of America Merrill Lynch said.