Easing does it: Emerging market central banks drink the QE Kool-Aid

The International Monetary Fund (IMF), in its latest Global Financial Stability Report, noted that the “new game in town” was asset purchases by emerging market central banks. 

“During the Covid-19 crisis, for the first time on a broad basis, at least 18 emerging market central banks adopted unconventional policies through the use of asset purchase programmes targeting government or private sector bonds in local currency,” the IMF said.

In the case of economies such as South Africa’s, where interest rates are well above zero, the IMF said the aim of such purchases was to provide liquidity to the financial sector. In economies with relatively low rates, such as Poland’s, the aim was also for monetary stimulus, mirroring a “somewhat similar” reason to that of advanced economies.

Some central banks also “explicitly stated that one of their objectives was to temporarily ease government financing pressure in the face of the once-in-a-generation global pandemic (Ghana, Guatemala, Indonesia, and the Philippines through its repurchase agreement),” the IMF said.

So, what was the upshot of this flurry of bond buying by emerging market central banks?

For one thing, the interventions helped to reduce “stress” in the financial sector. For the purposes of this analysis, the IMF developed a novel market conditions index, the local stress index (LSI). It measures stress levels in local bond and foreign currency markets by using gauges such as spreads between bids and offers, and overall volatility.

“The level of stress in local markets during the Covid-19 sell-off, as measured by the LSI, was comparable to that of the global financial crisis, but the period of stress was considerably shorter,” the IMF said. “In aggregate, the level of stress was well above that of previous episodes, such as the 2013 taper tantrum and 2014-15 stress episodes. However, markets have been normalising much faster than during previous episodes.”

So the “stress” and volatility that hit emerging bond markets during the initial stage of the pandemic was on a par with the global financial crisis of more than a decade ago. But markets are “destressing” at a much faster rate, it seems, because of central bank interventions that were little used at the time by emerging economies. 

Among other things, this seems to suggest that many emerging economies have matured and developed more sophisticated financial markets and instruments over the past decade. This is borne out by what happened in emerging forex markets, which experienced less stress than in 2008-2009.

The IMF said one of the likely reasons for this state of affairs was “structural shifts in the operation of FX markets since the global financial crisis, including increased turnover in emerging market currencies and electronic trading and a larger set of market-making institutions”.

Still, bond markets were highly stressed at first.

“Unlike FX markets, local bonds are still traded largely domestically, and market depth has not matched higher foreign participation, which could induce volatility,” the IMF said. Local is not always lekker.

The domestic asset purchases were also not found to have a big impact on emerging currency markets, but they brought bond yields down as stability returned to local debt markets. Yields on the 10-year South African government bond at the end of March spiked to around 12.3% but are back to or near pre-Covid levels, around 9.3%.

“The experience with emerging market asset purchase programmes has been largely positive so far, though further expansion of duration or size could create risks and thus warrant an ongoing evaluation of risks. Beyond the pandemic, this positive experience may motivate more emerging market central banks to consider unconventional monetary policy as a key additional part of their policy toolkit, especially where conventional policy space becomes limited,” the IMF said.

It does seem that the emerging market experiment with “unconventional monetary policy” has yielded at least some of its intended objectives, which is no bad thing. And provided populists don’t take control of the currency printing presses, it can be a viable policy option. Stay tuned for more measures from emerging markets along these lines. DM/BM