EM Central Banks Enter Uncharted Policy Waters


The policy response to the pandemic-driven financial crisis has been extraordinary for emerging markets (EM)—not only in terms of magnitude, but more importantly, in terms of the policy tools deployed. In previous episodes of a sudden stop in capital flows, EM policymakers moved quickly to defend their currencies by hiking rates. But this time, their primary concern has been to protect growth at any cost.

Several EM central banks have announced programs to buy government bonds in the primary and secondary markets, with some of them printing money to fund their purchases. Indeed, this is uncharted territory.

Policymakers Look to QE to Address Extraordinary Challenges  

The COVID-19 pandemic has created unprecedented global financial challenges, and the damage to economic growth will be more severe than that of prior global recessions. This explains why some EM countries believe QE programs are necessary. The 2008-2009 global financial crisis spared many EM countries from recession, largely due to China’s economy, which was growing at an annual rate of 9% to 10%. This growth helped the broad EM universe end 2009 with real GDP growth of 2.8%.1 This time, though, China’s economy is struggling, and EM economies collectively may contract 1% in 2020. In fact, several EM countries will face their worst recessions in many decades. See Figure 1.

In addition, fiscal deficits are expected to reach double digits in some countries by the end of the year, with financing needs far beyond the scope of domestic markets. See Figure 1. Central banks are most concerned with rising yields and the associated cost of borrowing. They hope QE measures will help control yield levels, particularly at the longer end of the curve. This is a crisis of liquidity, so many central banks want to provide as much liquidity as necessary.

Source: Bloomberg and Haver Analytics as of 5/20/2020.

1 International Monetary Fund, “World Economic Outlook,” April 2020.

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EM Central Banks Enter Uncharted Policy Waters

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