Central bankers in emerging markets have put up a decent show during the coronavirus crisis, in contrast to some of their governments. Even as death rates soar in the worst-affected countries, EM monetary policy — with a huge assist from the US Federal Reserve — has kept the worst of the potential financial stress at bay.
The question is whether today’s relative stability can be sustained or if, at the other extreme, the economic stress of the pandemic will tip investors into an old-style EM crisis.
The most eye-catching policy feature of recent months is what many, including these countries’ central bankers, have described as quantitative easing — bond-buying programmes announced by at least 17 EM central banks since March. Adam Wolfe, of Absolute Strategy Research, a consultancy, goes so far as to describe this shift as “a revolution in EM central banking”.
It may not be what is usually understood to be QE: the means by which the Fed and its counterparts have bought bonds to bring down long-term interest rates — when short-term policy rates are already as low as governors are willing to let them go — in the hope of stimulating the economy. Even after recent cuts, interest rates in most emerging economies engaging in QE are still some way above the lower bound, although they are close to it in Poland, Chile and Thailand. Rather, most EM central bankers are using QE to secure the smooth functioning of local bond markets in the face of the turmoil brought on by the pandemic.
By some measures, they have achieved spectacular success. Of the roughly $89bn of cross-border flows out of EM bond and equity markets during the panic selling in March, according to the Institute of International Finance, $33.5bn was from bonds. Since then, almost $62bn has flown back into EM debt markets. In aggregate across these economies, local bond yields are lower today than they were before the start of the crisis, as prices have recovered, and currencies have regained much of their losses against the dollar.
This owes much to central banks in advanced markets, which have poured trillions of dollars into financial markets to stave off a liquidity crisis, some of which has made its way to EMs. The Fed also opened swap lines with other central banks, including those in Brazil, Mexico and South Korea, providing an extra backstop.
But EM central banks have also played their part. Poland’s had spent the equivalent of more than 4 per cent of gross domestic product on bond purchases before the end of June, about half of what many analysts expect it to spend on QE overall. Chile, Colombia, Indonesia and Thailand will all spend the equivalent of 3 per cent of GDP or more, according to data compiled by ASR. Others, such as Brazil, India and Korea, will spend much less.
Most countries have introduced lending facilities and relaxed reserve requirements and other constraints on banks. Some, including Indonesia, have engaged in outright government financing to support the fiscal response to the crisis.
ASR’s Mr Wolfe said that many EMs had so far been able to retain the confidence of investors in part because “decades of building up central bank credibility have paid off”. Unsurprisingly, it is those central banks that in past years have let their currencies float while concentrating on stabilising inflation that have now delivered better outcomes.
Whether the strategy will continue to work depends on the size of the economic hit from the crisis, and whether governments have the resources to deal with it. A further sell-off would mean rising borrowing costs that could push economies into default.
The other risk is that old habits return. The temptation to ease debt burdens by allowing inflation to rise may become overwhelming. Patrick Zweifel, chief economist at Pictet Asset Management, thinks Turkey has already succumbed.
“Turkey has clearly once again opted for high inflation; it is printing money like hell,” he said, noting that the country’s M1 — a narrow measure of cash in circulation — was growing at close to 60 per cent a year. For EM-watchers, this brings back memories of countries using the printing presses to make debts go away, and of the consequences.
Perhaps those historical parallels will be enough to deter policymakers. The impulse to bow to cyclical pressures and return to the habits of the past must be set against the “loss of credibility” that would result, said Mr Zweifel, and with it, countries’ ability to fund themselves.
The crisis is not over. Were the virus to surge again, and the US dollar to resume its march higher — pushing up EMs’ debt-servicing costs — all bets would be off. This was the “narrow path” that central bankers were walking, said Mr Zweifel. “They are doing well, for the time being.”