OREANDA-NEWS. Fitch Ratings says in a new report that the divergence in global monetary policy, the slowdown in China, weak commodity prices and volatile risk appetite are creating exchange rate pressures for countries caught in the crosswinds. Commodity producers with US dollar pegs are among those most at risk of currency misalignment and therefore painful macroeconomic adjustment or potential exchange rate correction.

The US dollar's 29% appreciation in the five years to June 2016 in trade-weighted terms is the main cause of pressure on other countries' exchange rates. Fitch expects some renewed dollar strength in 2H16. Currency movements in China and Russia are also generating spill-overs. Abrupt exchange rate adjustments since 2015 in Azerbaijan, Egypt, Kazakhstan, Nigeria and Suriname highlight potential pressures. Fitch does not expect a major depreciation of the yuan as it could impede China's rebalancing and trigger global instability.

Fitch has tracked changes in real effective exchange rates (REERs) - trade-weighted nominal exchange rates adjusted for relative changes in consumer prices - for Fitch-rated 89 countries to gauge potential currency misalignments. The following have seen the greatest recent real appreciations (all over 15% since 1Q10): Venezuela, Bolivia, Mongolia, China, Costa Rica, Ecuador, Saudi Arabia, Egypt, Vietnam, Hong Kong, Kuwait, Philippines, Ethiopia and Bahrain. The report assesses the associated risks.

Since 2000, there have been 54 occasions (in the 89 country sample) of REER appreciation of 25% or more within a three-year period. Nearly one quarter were followed by a sovereign rating downgrade in two years. There were 24 REER depreciations of at least 25% in a three - year period, of which nearly two-thirds were downgraded in the preceding or following year.

REERs of countries with floating exchange rates have depreciated since 1Q10 by more than those with managed floats or 'largely-fixed' regimes. Commodity exporters with free or managed floats have seen some of the sharpest depreciations, but many which have 'largely-fixed' regimes have experienced appreciation, often moving them out of line with fundamentals.

Allowing floating exchange rates to depreciate can help to improve competitiveness, narrow current account deficits, preserve foreign currency reserves and improve fiscal positions. However, devaluation is not necessarily an easy option. Adverse effects can include faster inflation, higher debt service burdens or stresses in banking sectors if foreign currency exposures are material, lower real incomes and potentially heightened political tensions.

Although temporary misalignments of fixed exchange rates are bound to occur in the event of shocks, regime change may not be optimal for economic and financial stability. REER appreciation is not necessarily a credit concern if the shock is temporary or policy adjustments are made to correct the misalignment, and the country has a sufficiently strong balance sheet or policy credibility to manage that transition period. Fitch does not believe the GCC countries will devalue their USD pegs.

Countries that choose to maintain fixed exchange rate regimes in the face of substantial REER appreciation that are unwarranted by fundamentals will likely face a period of painful adjustment to return the REER and budget and current account balances closer to equilibrium. This will typically involve lowering domestic wages and prices to regain competitiveness against trading partners, which implies a period of below-trend growth.

REER appreciations may reflect benign productivity growth or structural shifts, but can also reflect a decline in the terms of trade, a loss of competitiveness or macroeconomic imbalances. Warning signals gain weight for countries with current account deficits, rapidly declining foreign exchange reserves or which are experiencing credit bubbles.