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### Background and authors
- Chapter title: EMERGING MARKET RESILIENCE: GOOD LUCK OR GOOD POLICIES?
- Publication context: WORLD ECONOMIC OUTLOOK; International Monetary Fund | October 2025.
- Authors and contributors:
  - Authors: Marijn A. Bolhuis; Francesco Grigoli (co-lead); Andrea Presbitero (co-lead); Zhao Zhang.
  - Contributions from: Thomas J. Carter; Marcin Kolasa; Jesper Linde; Giulio Lisi; Rui Mano; Roland Meeks; Hedda Thorell.
  - Research assistance: Pedro Henrique de Barros Gagliardi; Weili Lin.
  - Chapter benefited from comments by Anusha Chari, Enrique Mendoza, and internal seminar participants and reviewers.

### Scope, sample, and methodology
- Sample:
  - 26 emerging markets—covering about 88 percent of GDP of emerging markets and middle-income economies.
  - 30 advanced economies.
- Period split:
  - Pre-GFC period is 1997–2009.
  - Post-GFC period is 2010–24.
- Identification and metrics:
  - Risk-off episodes identified using an extended version of the RORO Index of Chari, Dilts Stedman, and Lundblad (2023).
  - External conditions calculated as the weighted change in real GDP for AEs, the commodity price–based terms of trade index for EMs, and the average of the US FCI-G index, measured six months following the start of a risk-off episode.
  - FX-related macroprudential regulation metric is the cross-country average of cumulative net tightening actions related to capital requirements for banks; limits on foreign currency lending and rules or recommendations on foreign currency loans; and limits on net or gross open FX positions, FX exposures and funding, and currency mismatch regulations.

### Stylized facts on risk-off episodes and EM performance
- Historical vulnerability:
  - Emerging markets historically vulnerable to global risk-off events, experiencing capital outflows, currency depreciations, tightened financial conditions, and associated output losses and inflation surges.
- Recent evolution:
  - Since the global financial crisis many emerging markets have displayed remarkable resilience in financial and economic conditions to external shocks.
  - The magnitude and duration of risk-off shocks have not meaningfully changed, nor have the underlying financial factors leading to these shocks; however, most emerging markets since the global financial crisis experienced smaller output contractions and negligible inflationary pressures.
- External environment contributors to post-GFC resilience:
  - Steady growth in advanced economies, favorable terms of trade, easier financial conditions after the global financial crisis, spillovers from China’s sustained growth and integration, long-term financing at historically low rates for sovereign and corporate bond issuers, and the relatively strong US recovery and soft landing following the Federal Reserve’s tightening cycle.

### Evolution of policy frameworks and implementation
- Monetary policy:
  - Adoption of inflation targeting and greater exchange rate flexibility enhanced capacity to absorb external shocks.
  - Long-term inflation expectations became better anchored, reducing currency depreciation pass-through to prices and inflation persistence.
  - Central banks in emerging markets, especially those with stronger policy frameworks, responded to postpandemic inflation with swifter and more forceful monetary tightening than in previous cycles and, in many cases, earlier than advanced economy counterparts.
  - Central banks increasingly focused on output stabilization rather than exchange rate management; financial markets’ expectations align more closely with policy decisions.
  - Domestic monetary policy shocks transmit effectively to short-term yields; US monetary policy still influences longer-term yields and riskier asset classes.
- Macroprudential and financial stability measures:
  - Tighter macroprudential policies reduced foreign exchange mismatches and limited the share of foreign currency debt.
  - Improvements in governance and debt management contributed to borrowing at longer maturities and deeper local currency bond markets; increased participation of domestic investors in local currency debt markets in countries with strong frameworks.
- Fiscal policy:
  - Enhanced fiscal credibility (for example, via fiscal rules) lessened fiscal dominance concerns and supported de-dollarization of debt.
  - Fiscal stance in emerging markets—measured as the primary-balance-to-GDP ratio—has been relatively restrained postpandemic.
  - Presence of fiscal rules did not guarantee implementation; unwarranted deviations are common, leading to buildup of debt vulnerabilities in some regions (notably Latin America).

### Quantified contributions to resilience
- Estimated gains from improved policy frameworks (comparing typical post-GFC risk-off episodes with pre-GFC):
  - Improved policy frameworks accounted for 0.5 percentage point higher growth.
  - Improved policy frameworks accounted for 0.6 percentage point lower inflation.
  - Favorable external conditions contributed another 0.5 percentage point higher growth but did not ease inflationary pressures.
- Aggregate balance-sheet and liability changes since the global financial crisis:
  - Average net foreign asset position increased by 13 percent of GDP relative to the period before the crisis.
  - The share of external liabilities denominated in domestic currency rose by 12.5 percentage points.
- Improvements in sudden-stop risk:
  - Probability of experiencing a sudden stop fell by half, to 1.5 percent.
  - Average credit spread during sudden stops fell from 6.2 percent to 5.2 percent.

### Model simulations and scenarios (Q‑IPF model)
- Model setup:
  - Q‑IPF includes four key frictions:
    1. Limited risk-bearing capacity in the foreign exchange market (UIP risk premium fluctuations).
    2. An occasionally binding external debt limit that can trigger sudden stops.
    3. Weakly anchored inflation expectations producing high exchange rate pass-through.
    4. Balance sheet foreign exchange mismatches that amplify contractionary impacts.
  - Calibrated to two archetypes: pre-global financial crisis average EM (weak frameworks) and postcrisis average EM (strong frameworks). Foreign economy set to the US.
- Policy-trade-off scenario: 10 percent nominal exchange rate depreciation (risk-off shock)
  - Strong-framework EM:
    - Output declines by 0.1 percentage point.
    - Inflation rises by 0.2 percentage point.
    - Monetary policy can prioritize output stabilization; higher net exports support output.
  - Weak-framework EM:
    - Output contracts by 0.3 percentage point.
    - Inflation increases by 1 percentage point.
    - Greater exchange rate pass-through forces aggressive monetary tightening.
- Costs of delaying monetary tightening (10 percent depreciation plus 0.5 percentage point persistent cost-push inflation):
  - For weak-framework EMs comparing regimes:
    - Late tightening requires an eventual rate hike of 1.4 percentage points more than a standard Taylor-rule response.
    - Output contraction is 0.7 percent of GDP larger five quarters after the shocks.
    - Both regimes bring inflation back to target by the end of the third year, but late tightening magnifies output costs and persistent inflation dynamics.
- Foreign exchange intervention (FXI) assumed specification:
  - Central bank runs down reserves by 3 percent of GDP; without intervention depreciation is 10 percent; with intervention depreciation is halved.
  - Effects in weak-framework EMs:
    - Two years after shock cumulative price increase is 0.7 percentage point lower than without intervention.
    - Intervention reduces output loss by 0.9 percentage point relative to no intervention.
  - Effects in strong-framework EMs:
    - Inflation is 0.1 percentage point lower with FXI; output is marginally higher as nominal depreciation boosts net exports.
  - Note: FXI effectiveness depends on foreign exchange market depth (assumed identical across calibrated EMs).

### Evidence on risk-off episodes and asset-price transmission
- RORO Index extension identifies 16 risk-off episodes (1997 through end-2024), evenly split pre- and post-GFC.
- Episode characteristics:
  - Average increase of about one standard deviation and duration about five months in both pre-GFC and post-GFC periods.
  - Largest episodes: global financial crisis and the pandemic.
  - Longest episodes: subprime crisis starting in June 2007 and global growth scare starting in May 2015; both lasted 10 months.
- Contributions to RORO variance during episodes:
  - About 45 percent explained by credit spreads.
  - Just above 40 percent explained by equity volatility.
  - About 10 percent explained by liquidity risks.
  - Remainder explained by currency risks.
- Comparative effects pre-GFC versus post-GFC (six months after start of episode):
  - Output losses: precrisis 1.8 percent of GDP; postcrisis 1 percent of GDP.
  - Price increase: precrisis 0.9 percent; postcrisis the 0.9 percent price increase disappeared.
- Monetary shock pass-through:
  - A one-standard-deviation domestic monetary policy shock raises the three-month yield by about 10 basis points.
  - A one-standard-deviation domestic monetary policy shock appreciates the currency by 7 basis points and lowers stock prices by 9 basis points.
  - A one-standard-deviation US monetary policy shock leads to a 24 basis point decline in stock prices, a 15 basis point exchange rate depreciation, and a 57 basis point widening of credit spreads; pass-through to short-term domestic borrowing conditions is considerably smaller and not statistically significant, but effects on 10-year yields are broadly comparable to domestic shocks.

### Central bank independence, political interference, and precautionary instruments
- Risks of political interference:
  - Sample: 134 governor transitions (11 advanced economies; 16 emerging markets) since 2000.
  - Politically motivated transitions:
    - Emerging markets: 50 transitions (about half).
    - Advanced economies: 5 transitions (8 percent).
  - Inflation expectations:
    - About 1 percent above targets where politically motivated transitions are the majority.
    - Over 2 percent above targets where politically motivated transitions are the norm.
  - Six months after politically motivated transitions (difference-in-differences local projections):
    - Real rates fall by 1.6 percentage points.
    - Exchange rates depreciate by 3.1 percent.
    - Inflation and inflation expectations rise by 1.7 percentage points.
- IMF precautionary instruments (FCL, PLL, SLL):
  - Announcements of new FCL and SLL arrangements show spreads remain more than 20 basis points lower than synthetic counterparts in the 60 trading days following announcement.
  - Local projections indicate qualifying emerging markets with precautionary arrangements experienced significantly smaller increases in spreads and capital outflows during the two most recent risk-off episodes compared with peers with similar fundamentals.

### Fiscal frameworks, cyclicality, and debt dynamics
- Fiscal-rule progress:
  - IMF’s Fiscal Rule Strength Index shows continued improvement in legal basis, monitoring, enforcement, and flexibility of fiscal rules in emerging markets, but emerging markets on average still lag advanced economies.
- Fiscal cyclicality:
  - Some emerging markets have shifted from procyclical to countercyclical fiscal policy since the global financial crisis; degree of countercyclicality has moved closer to advanced economies, especially after global downturns.
- Fiscal reaction functions and debt:
  - Sensitivity of the primary balance to debt levels and interest expenditure has increased since the global financial crisis.
  - Sensitivity to the interest bill has become close to 1 and exceeds that of advanced economies.
  - Sovereign spreads remain sensitive to debt burdens; even with more aggressive fiscal responses, speed of debt reduction after adverse shocks is relatively slow under illustrative assumptions with (r − g) of 0 and (r − g) of 2 percent.

### Policy recommendations and implications
- Strengthen policy frameworks:
  - Continue adopting and credibly implementing inflation-targeting regimes, fiscal rules, and macroprudential regulations.
  - Safeguard and reinforce central bank independence, particularly when inflation is low but fiscal pressures are mounting.
  - Build credibility so long-term inflation expectations remain anchored, allowing greater monetary autonomy and more effective policy trade-offs.
- Monetary policy sequencing and timing:
  - Emerging markets with weak policy frameworks should avoid delaying monetary tightening in the face of risk-off and persistent cost-push shocks; delay leads to larger eventual rate hikes and deeper output losses.
  - Clear communication of objectives and reaction functions helps anchor inflation expectations and eases policy trade-offs.
- Use of foreign exchange interventions:
  - FX interventions can contain depreciation and lower the need for rate hikes in weaker-framework countries but are not a substitute for stronger frameworks and yield diminishing benefits as frameworks mature.
  - FXI assumed here involves using reserves (3 percent of GDP) and halving depreciation in the modeled scenario.
- Fiscal policy:
  - Strengthen fiscal guardrails and credible medium-term frameworks to maintain discipline amid uncertainty and mounting spending pressures.
  - Adopt risk-based fiscal anchors tailored to debt-carrying capacity and robust correction mechanisms to improve compliance with rules.
  - Sound public debt management and deepening local currency bond markets (with greater resident investor participation) support resilience.
- Broader guidance:
  - Evidence points to a gradual shift toward a world more consistent with the Mundell-Fleming trilemma for countries with stronger frameworks, enabling greater domestic monetary policy autonomy.
  - Remaining risks: unfavorable external conditions, rising global interest rates, geopolitical tensions, higher public-debt-to-GDP ratios, and potential policy backsliding warrant vigilance.

*Source: ch2 - Introduction, World Economic Outlook; International Monetary Fund | October 2025.*

### Introduction

### ch2 - Introduction

### Background and authors
- Chapter title: EMERGING MARKET RESILIENCE: GOOD LUCK OR GOOD POLICIES?
- Publication context: WORLD ECONOMIC OUTLOOK; International Monetary Fund | October 2025.
- Authors and contributors:
  - Authors: Marijn A. Bolhuis; Francesco Grigoli (co-lead); Andrea Presbitero (co-lead); Zhao Zhang.
  - Contributions from: Thomas J. Carter; Marcin Kolasa; Jesper Linde; Giulio Lisi; Rui Mano; Roland Meeks; Hedda Thorell.
  - Research assistance: Pedro Henrique de Barros Gagliardi; Weili Lin.
  - Chapter benefited from comments by Anusha Chari, Enrique Mendoza, and internal seminar participants and reviewers.

### Scope, sample, and methodology
- Sample:
  - 26 emerging markets—covering about 88 percent of GDP of emerging markets and middle-income economies.
  - 30 advanced economies.
- Period split:
  - Pre-GFC period is 1997–2009.
  - Post-GFC period is 2010–24.
- Identification and metrics:
  - Risk-off episodes identified using an extended version of the RORO Index of Chari, Dilts Stedman, and Lundblad (2023).
  - External conditions calculated as the weighted change in real GDP for AEs, the commodity price–based terms of trade index for EMs, and the average of the US FCI-G index, measured six months following the start of a risk-off episode.
  - FX-related macroprudential regulation metric is the cross-country average of cumulative net tightening actions related to capital requirements for banks; limits on foreign currency lending and rules or recommendations on foreign currency loans; and limits on net or gross open FX positions, FX exposures and funding, and currency mismatch regulations.

### Stylized facts on risk-off episodes and EM performance
- Historical vulnerability:
  - Emerging markets historically vulnerable to global risk-off events, experiencing capital outflows, currency depreciations, tightened financial conditions, and associated output losses and inflation surges.
- Recent evolution:
  - Since the global financial crisis many emerging markets have displayed remarkable resilience in financial and economic conditions to external shocks.
  - The magnitude and duration of risk-off shocks have not meaningfully changed, nor have the underlying financial factors leading to these shocks; however, most emerging markets since the global financial crisis experienced smaller output contractions and negligible inflationary pressures.
- External environment contributors:
  - Factors cited as contributing to resilience include steady growth in advanced economies, favorable terms of trade, easier financial conditions after the global financial crisis, spillovers from China’s sustained growth and integration, long-term financing at historically low rates for sovereign and corporate bond issuers, and the relatively strong US recovery and soft landing following the Federal Reserve’s tightening cycle.

### Evolution of policy frameworks and implementation
- Monetary policy:
  - Adoption of inflation targeting and greater exchange rate flexibility enhanced capacity to absorb external shocks.
  - Long-term inflation expectations became better anchored, reducing currency depreciation pass-through to prices and inflation persistence.
  - Central banks in emerging markets, especially those with stronger policy frameworks, responded to postpandemic inflation with swifter and more forceful monetary tightening than in previous cycles and, in many cases, earlier than advanced economy counterparts—pointing to increased monetary policy autonomy.
  - Central banks increasingly focused on output stabilization rather than exchange rate management; financial markets’ expectations align more closely with policy decisions, signaling improved credibility.
  - Domestic monetary policy shocks transmit effectively to short-term yields; US monetary policy still influences longer-term yields and riskier asset classes.
- Macroprudential and financial stability measures:
  - Tighter macroprudential policies reduced foreign exchange mismatches and limited the share of foreign currency debt, mitigating financial stability concerns and reducing need for foreign exchange interventions.
  - Improvements in governance and debt management contributed to borrowing at longer maturities and deeper local currency bond markets; increased participation of domestic investors in local currency debt markets in countries with strong frameworks.
- Fiscal policy:
  - Enhanced fiscal credibility (for example, via fiscal rules) lessened fiscal dominance concerns and supported de-dollarization of debt, containing sovereign risk premiums.
  - Fiscal stance in emerging markets—measured as the primary-balance-to-GDP ratio—has been relatively restrained postpandemic, a shift from past crises when consolidation was often delayed.
  - Presence of fiscal rules did not guarantee implementation; unwarranted deviations are common, leading to buildup of debt vulnerabilities in some regions (notably Latin America).
  - Stronger fiscal frameworks allowed fiscal policy to react more to slack and to debt sustainability pressures, improving ability to stabilize debt; however, sovereign spreads remain sensitive to debt burdens.

### Quantified contributions to resilience
- Estimated gains from improved policy frameworks (comparing typical post-GFC risk-off episodes with pre-GFC):
  - Improved policy frameworks accounted for 0.5 percentage point higher growth.
  - Improved policy frameworks accounted for 0.6 percentage point lower inflation.
  - Favorable external conditions contributed another 0.5 percentage point higher growth but did not ease inflationary pressures.
- Model simulation result:
  - In response to a 10 percent nominal exchange rate depreciation triggered by a risk-off shock, economies with strong policy frameworks (as in the period after the global financial crisis) experience 85 percent smaller output contractions.

### Key interpretive conclusions
- The observed resilience is not solely due to benign external conditions (“good luck”); it is also rooted in improved policy frameworks (“good policies”).
- Evidence suggests a progressive transition toward a world more consistent with the Mundell-Fleming trilemma (monetary policy independence, exchange rate flexibility, and open capital accounts) and less with the dilemma described in Rey (2015) where monetary policy independence is limited unless capital controls are used.
- Central banks have become less sensitive to fiscal pressures and retain traction over domestic borrowing conditions.

### Core policy questions addressed
- How did emerging markets fare during risk-off episodes, and has performance improved?
- How have monetary, macroprudential, and fiscal policy frameworks evolved in practice (implementation, credibility, outcomes)?
- To what extent can recent resilience be attributed to good luck versus good policies?
- How should emerging markets deal with future risk-off shocks—what is the appropriate policy mix and timing for countries with weaker policy frameworks?

### Policy recommendations and implications
- Sustain efforts to strengthen policy frameworks, as these:
  - Enhance ability to withstand risk-off shocks by easing policy trade-offs and reducing the likelihood of sudden stops.
  - Reduce the extent of monetary policy tightening required to contain inflation and allow a shift in focus toward output stabilization.
- Policy sequencing and calibration:
  - Stronger policy frameworks reduce the need for foreign exchange interventions.
  - Countries with weaker frameworks require careful assessment of policy mix and timing during episodes of global financial stress; improved frameworks accrue measurable gains in policy trade-offs.

_Source: ch2 - Introduction, World Economic Outlook; International Monetary Fund | October 2025._

### CHAPTER 2 EMERGING MaRKET REsILIENCE: GOOD LUCK OR GOOD POLICIEs?

### CHAPTER 2 EMERGING MaRKET REsILIENCE: GOOD LUCK OR GOOD POLICIEs?

### Summary of main findings
- Improved balance sheets cut in half the risk of sudden stops and reduce their severity.
- Emerging markets with weak policy frameworks that delay monetary tightening face steeper costs:
  - In response to a 10 percent nominal exchange rate depreciation and a 0.5 percentage point increase in inflation, policy rates need to rise by as much as 1.4 percentage points more than in comparable emerging markets that follow a standard Taylor rule to eventually bring inflation back to target.
  - Resulting output contractions are 0.7 percentage point larger five quarters after the shocks.
- Foreign exchange interventions:
  - Help contain inflation and limit output losses associated with monetary tightening in countries with weak policy frameworks.
  - In emerging markets with weak frameworks, foreign exchange interventions reduce output losses by 0.9 percentage point two years after the shock compared with a no-intervention scenario.
  - Benefits are marginal in countries with strong frameworks, where inflation expectations are well anchored and the exchange rate supports net exports; interventions are not a substitute for stronger policy frameworks.
- Despite gains, emerging markets’ resilience remains vulnerable to deteriorations in external conditions, limited fiscal space after recent global shocks, and policy backsliding; maintaining progress requires safeguarding central bank independence when inflation is low and fiscal pressures mount.

### Evidence on risk-off episodes and emerging market responses
- The RORO Index extension (1997 through end-2024) and algorithm-based dating identify 16 risk-off episodes, evenly split before and after the global financial crisis.
- Characteristics of episodes:
  - On average, episodes registered an increase of about one standard deviation and lasted about five months in both pre-GFC and post-GFC periods.
  - The largest episodes were the global financial crisis and the pandemic.
  - The longest episodes were the subprime crisis starting in June 2007 and the global growth scare starting in May 2015; both lasted 10 months.
- Contributions to RORO variance during episodes:
  - About 45 percent explained by credit spreads.
  - Just above 40 percent explained by equity volatility.
  - About 10 percent explained by liquidity risks.
  - Remainder explained by currency risks.
- Comparative effects pre-GFC versus post-GFC:
  - Since the global financial crisis, risk-off episodes have not been accompanied by outsized portfolio outflows; exchange rate pass-through has become muted; the increase in sovereign spreads is about one-fifth of what it used to be before the global financial crisis.
  - Six months after the start of a risk-off episode:
    - Output losses are smaller in the postcrisis period (1 percent of GDP) compared with the precrisis period (1.8 percent of GDP).
    - The precrisis 0.9 percent price increase disappeared after the crisis.

### Evolution of policy frameworks and mechanisms
- Monetary policy implementation and reaction functions:
  - Postcrisis policymakers are less concerned about exchange rate fluctuations, consistent with smaller pass-through to prices and a shift toward inflation as the nominal anchor.
  - The weight associated with deviations of one-year-ahead expected inflation from the target declined in the postcrisis period, likely reflecting improved central bank credibility and more strongly anchored long-term inflation expectations.
  - Sensitivity of three-year-ahead inflation forecasts to changes in one-year-ahead expected inflation declined substantially after the global financial crisis.
  - Central banks in emerging markets have shifted attention toward curbing output fluctuations; the postcrisis reaction function displays a desirable countercyclical bias and is close to that of advanced economies.
- Perceived reaction function and credibility:
  - Survey-based estimates show a progressive decline in the magnitude of the Taylor rule coefficient on expected inflation over time and a marginal increase in the size of the output gap coefficient, pointing to gains in monetary policy credibility.
- Central bank independence and fiscal dominance:
  - Prior to the global financial crisis, evidence suggests fiscal dominance: increases in military spending were followed by monetary easing and higher expected inflation.
  - Since the global financial crisis, central banks no longer accommodate fiscal spending; long-term inflation expectations remain close to target, similarly to advanced economies.
- Autonomy relative to US monetary policy:
  - The chapter examines responses of government bond yields, nominal exchange rates, stock prices, and EMBI spreads to domestic and US monetary policy shocks to assess autonomy; results and interpretation are provided in figure-based analysis.

### Policy implications and recommendations
- Emerging markets with weak policy frameworks should avoid delaying monetary tightening in the face of risk-off and persistent cost-push shocks; delay leads to larger eventual rate hikes and deeper output losses.
- Foreign exchange interventions can be a useful tool to contain exchange rate depreciation, lower the need for rate hikes, and reduce output losses in countries with weak frameworks—but they are not a substitute for better policy frameworks.
- Strengthening policy frameworks remains critical to resilience:
  - Continue adopting and credibly implementing inflation-targeting regimes, fiscal rules, and macroprudential regulations.
  - Safeguard and reinforce central bank independence, particularly when inflation is low but fiscal pressures are mounting.
  - Build credibility so that long-term inflation expectations remain anchored, allowing greater monetary autonomy and more effective policy trade-offs.

*Source: CHAPTER 2 EMERGING MaRKET REsILIENCE: GOOD LUCK OR GOOD POLICIEs? (PDF chapter).*

### CHAPTER 2 EMERGING MaRKET REsILIENCE: GOOD LUCK OR GOOD POLICIEs?

### CHAPTER 2 EMERGING MaRKET REsILIENCE: GOOD LUCK OR GOOD POLICIEs?

### Monetary policy shocks and pass-through to emerging markets
- Domestic monetary policy shocks transmit strongly to government bond yields, especially at the short end of the yield curve:
  - A one-standard-deviation domestic monetary policy shock raises the three-month yield by about 10 basis points.
- US monetary policy shocks show a considerably smaller—and not statistically significant—pass-through to short-term domestic borrowing conditions, but effects on 10-year yields are broadly comparable to domestic shocks.
- US monetary policy shocks have larger effects on riskier asset classes:
  - A one-standard-deviation US monetary policy shock leads to a 24 basis point decline in stock prices.
  - A one-standard-deviation US monetary policy shock leads to a 15 basis point exchange rate depreciation.
  - A one-standard-deviation US monetary policy shock leads to a 57 basis point widening of credit spreads.
- A one-standard-deviation domestic monetary policy shock:
  - Appreciates the currency by 7 basis points.
  - Lowers stock prices by 9 basis points.

### Foreign exchange interventions
- Emerging markets historically exhibit fear of floating due to concerns over balance sheet mismatches, pass-through to inflation, and financial instability.
- Many emerging markets continued exchange rate management after adopting inflation-targeting frameworks.
- Benefits of foreign exchange interventions diminish as policy frameworks mature and financial frictions ease.
- Cross-country variation findings:
  - Emerging markets with well-anchored inflation expectations intervene less in foreign exchange markets in response to uncovered interest parity (UIP) deviations triggered by risk-off episodes, as exchange rate pass-through tends to be lower.
  - When macroprudential regulation effectively limits the share of foreign currency debt, financial stability concerns are reduced and the need for foreign exchange intervention is diminished.
- Implication: Emerging markets with strong policy frameworks are more likely to allow deviations from UIP to play out rather than counteracting them by selling foreign currency.

### Fiscal policy frameworks and predictability
- The IMF’s Fiscal Rule Strength Index shows continued improvement in the legal basis, monitoring, enforcement, and flexibility of fiscal rules in emerging markets.
- Progress has been uneven; emerging markets on average still lag advanced economies.
- Countries often struggle to balance flexibility and resilience of fiscal rules against design complexity and ensuring escape clauses are reserved for events beyond policymakers’ control.
- Strong fiscal frameworks and fiscal rules can strengthen the credibility of official projections and help anchor private sector expectations.
- Professional forecasters have increasingly aligned their expectations of budget deficits with official projections:
  - “Current year forecasts” and “planned adjustment” measures are used (pre-GFC period 1997–2009; post-GFC period 2010–24).

### Fiscal cyclicality and debt sustainability
- Emerging markets historically implemented procyclical fiscal policy, driven by limited access to international credit during downturns and institutional weaknesses that encouraged loose fiscal policy during upswings.
- Since the global financial crisis, some emerging markets have graduated from procyclical to countercyclical fiscal policy:
  - On average, the degree of countercyclicality has moved closer to that of advanced economies.
  - Improvements in countercyclicality are most pronounced in the years following downturns in the global business cycle.
- Fiscal reaction functions and debt dynamics:
  - The sensitivity of the primary balance to debt levels and interest expenditure in emerging markets has increased since the global financial crisis.
  - The sensitivity to the interest bill has become close to 1 and exceeds that of advanced economies.
  - Sovereign spreads remain sensitive to debt burdens, especially during periods of financial stress.
  - Even with a more aggressive fiscal response, the estimated reaction functions imply that the speed at which debt is brought back down after an adverse shock is still relatively slow.
  - Illustrative simulation assumptions:
    - Low interest-growth differential (r − g) of 0.
    - High interest-growth differential (r − g) of 2 percent.

### Contribution of policy frameworks versus external conditions to resilience
- Two-stage analysis:
  - Stage 1: Proxies for the quality of policy frameworks predict growth and inflation during the 12 months following the start of a risk-off episode, using episode-specific fixed effects to hold external conditions constant.
  - Stage 2: Quantifies overall contributions of policy frameworks and external conditions to growth and inflation dynamics in the aftermath of risk-off shocks, accounting for observed changes before and after the global financial crisis.
- Key quantified effects:
  - An emerging market at the 75th percentile of lower foreign exchange mismatches is expected to experience 1.3 percentage point higher growth than an emerging market at the 25th percentile, holding the risk-off episode constant.
  - An emerging market at the 75th percentile in terms of anchoring of long-term inflation expectations tends to experience 1.3 percentage point lower inflation.
- Contributions decomposed for the median emerging market in the post-GFC period (2010–24) relative to the pre-GFC period (1997–2009) account for:
  - Monetary: anchoring of inflation expectations and reserve adequacy.
  - Macroprudential: FX mismatches and macroprudential policy measures.
  - Fiscal: external debt burden and the cyclically adjusted balance.
  - External conditions: real GDP growth in advanced economies, commodity terms-of-trade shocks, and US FCI-G index.
- Conclusion: Improved policy frameworks contributed substantially to resilience during recent risk-off episodes, raising growth and lowering inflation to degrees consistent with the strength of policy frameworks at episode onset.

*Source: CHAPTER 2 EMERGING MaRKET REsILIENCE: GOOD LUCK OR GOOD POLICIEs?, October 2025.*

### 0.5 percentage point and lowering inflation by 0.6 per-

### ch2 - 0.5 percentage point and lowering inflation by 0.6 per-

### Key empirical findings on resilience and policy frameworks
- Improved policy frameworks since the global financial crisis accounted for:
  - 0.5 percentage point higher growth (relative to the precrisis period).
  - 0.6 percentage point lower inflation (relative to the precrisis period).
- More benign external conditions contributed 0.5 percentage point to faster growth in emerging markets after the global financial crisis, but did not ease inflationary pressures.
- Average balance sheet and liability changes since the global financial crisis:
  - Average net foreign asset position increased by 13 percent of GDP relative to the period before the crisis.
  - The share of external liabilities denominated in domestic currency rose by 12.5 percentage points.
- Improvements in sudden-stop risk:
  - Probability of experiencing a sudden stop fell by half, to 1.5 percent.
  - Average credit spread during sudden stops fell from 6.2 percent to 5.2 percent.

### Q‑IPF model: setup and key frictions
- The quantitative Integrated Policy Framework (Q‑IPF) model includes four key frictions:
  1. Limited risk-bearing capacity in the foreign exchange market, generating uncovered interest parity risk premium fluctuations.
  2. An occasionally binding external debt limit that can trigger sudden stops.
  3. Weakly anchored inflation expectations producing high exchange rate pass-through to import and consumer prices.
  4. Balance sheet foreign exchange mismatches that amplify contractionary impacts of exchange rate changes.
- The model is calibrated to two small open emerging market archetypes:
  - Pre-global financial crisis average EM: subject to all four frictions (weak policy frameworks).
  - Postcrisis average EM: more strongly anchored inflation expectations and smaller balance sheet mismatches (strong policy frameworks).
- The foreign economy in the calibration is set to the US.

### Policy trade-offs in response to a risk-off shock (10 percent nominal depreciation)
- For the emerging market with strong policy frameworks:
  - Monetary policy can prioritize output stabilization because inflation expectations are better anchored.
  - Output declines by only 0.1 percentage point and inflation rises by 0.2 percentage point following the shock.
  - Higher net exports support output.
- For the emerging market with weak policy frameworks:
  - Greater exchange rate pass-through forces aggressive monetary tightening.
  - Output contracts by 0.3 percentage point and inflation increases by 1 percentage point for the same depreciation.

### Costs of delaying monetary tightening (risk-off shock plus persistent cost-push shock: 10 percent depreciation and 0.5 percentage point increase in inflation)
- Two monetary-policy regimes compared for EMs with weak frameworks:
  - Standard Taylor-rule (timely, aggressive response).
  - Late tightening (initially looks through inflation surge; later tightens more).
- Outcomes of late tightening:
  - Requires a substantially larger eventual rate hike of 1.4 percentage points.
  - Produces a more pronounced output contraction of 0.7 percent of GDP five quarters after the shock.
  - Both regimes bring inflation back to target by the end of the third year, but late tightening magnifies output costs and persistent inflation dynamics.

### Role and effects of foreign exchange interventions (FXI) assuming sufficient reserves
- FXI specifications:
  - Central bank intervenes by running down reserves by 3 percent of GDP.
  - Without intervention, nominal exchange rate depreciates by 10 percent.
  - With intervention, the depreciation is halved (intervention limits the rise in the uncovered interest parity risk premium).
- Effects in emerging markets with weak policy frameworks:
  - Residual depreciation still fuels inflation due to high pass-through, but two years after the shock cumulative price increase is 0.7 percentage point lower than without intervention.
  - Intervention moderates the need for monetary tightening and reduces the associated output loss by 0.9 percentage point.
- Effects in emerging markets with strong policy frameworks:
  - Benefits of intervention are more modest: inflation is only 0.1 percentage point lower with FXI, and output is marginally higher as nominal depreciation boosts net exports.
- Note: FXI effectiveness depends on foreign exchange market depth (assumed same across calibrated EMs); resulting depreciation with intervention is therefore identical across types in the model.

### Conclusions and policy implications
- Improved policy frameworks materially increased EM resilience to risk-off shocks; resilience is not solely luck.
- Aggregate contribution summary:
  - Improved frameworks: 0.5 percentage point higher growth and 0.6 percentage point lower inflation compared with the typical precrisis episode.
  - Favorable external conditions: contributed 0.5 percentage point to growth but did not ease inflation.
- Policy guidance distilled from empirical analysis and model simulations:
  - Monetary policy:
    - Clear communication of objectives and reaction functions helps anchor inflation expectations and eases policy trade-offs.
    - Reinforce and safeguard central bank independence to mitigate fiscal dominance risks.
  - Foreign exchange interventions:
    - Can stabilize less-resilient EMs temporarily but yield diminishing benefits as frameworks strengthen.
    - Should not substitute for efforts to anchor inflation expectations and reduce balance sheet mismatches.
  - Fiscal policy:
    - Stronger fiscal guardrails and a credible medium-term fiscal framework are needed to maintain fiscal discipline amid uncertainty and mounting spending pressures.
    - Risk-based fiscal anchors tailored to a country’s debt-carrying capacity and robust correction mechanisms can improve compliance with fiscal rules.
    - Sound public debt management and deepening local currency bond markets (with greater resident investor participation) support resilience.
  - Broader implications:
    - Evidence points to a gradual shift away from the dilemma toward the Mundell-Fleming trilemma for countries with stronger frameworks, enabling greater domestic monetary policy autonomy.
    - Countries with weaker frameworks should avoid delaying monetary tightening to prevent de-anchoring of expectations and larger output losses.
    - FX interventions can provide temporary relief in weaker-framework countries but are costly and should not postpone necessary reforms to anchor expectations and reduce mismatches.
- Remaining risks and cautions:
  - External conditions may turn unfavorable quickly; rising global interest rates and geopolitical tensions pose significant risks.
  - Higher public-debt-to-GDP ratios in many EMs limit fiscal space, underscoring the need to rebuild fiscal buffers.
  - Gains in credibility and institutional strength can be reversed; risks of policy backsliding warrant vigilance.

*Source: Chapter 2 (PDF): ch2 - 0.5 percentage point and lowering inflation by 0.6 per- — International Monetary Fund, October 2025.*

### Box 2.3 illustrates, central bank independence may

### ch2 - Box 2.3 illustrates, central bank independence may

### Overview
- Central bank independence may come under pressure from politically driven appointments, potentially leading to fiscal dominance, loss of credibility, and inflation surges.
- Fiscal rules could be weakened or disregarded if political economy pressures dominate, undermining fiscal credibility.
- Emerging markets’ recent progress and responses to shocks should be viewed as a foundation for further strengthening monetary, macroprudential, and fiscal policy frameworks and rebuilding policy buffers.

### IMF precautionary instruments
- Instruments: Flexible Credit Line (FCL), Precautionary and Liquidity Line (PLL), Short-Term Liquidity Line (SLL).
- Purpose: Provide qualifying members with up-front access to IMF resources, with no or limited conditionality; bolster market confidence and act as insurance against external shocks.
- Eligibility: Available to qualifying members with very strong (or sound, in the case of the PLL) economic fundamentals and policy frameworks, a sustained history of implementing (and currently implementing) very strong policies, and a commitment to maintain these policies.

### Evidence on effectiveness of precautionary instruments
- Event-study evidence: Announcements of new FCL and SLL arrangements show a significant and increasingly pronounced decline in sovereign spreads in the days following announcements (Figure 2.1.1, panel 1).
- Robustness note: On average, spreads remain more than 20 basis points lower than their synthetic counterparts in the 60 trading days following the announcement.
- Local projections with inverse propensity score weighting:
  - Emerging markets with precautionary arrangements experienced significantly smaller increases in spreads and capital outflows during the two most recent risk-off episodes, compared with peers with similar fundamentals (Figure 2.1.1, panel 2).
  - This suggests value of these instruments may increase in a shock-prone environment with recurring stress episodes.
- Specific arrangements analyzed:
  - FCL arrangements approved in 2009 for Colombia, Mexico, and Poland.
  - FCLs approved for Chile and Peru in 2020 (context: COVID-19 shock).
  - 2023 Morocco FCL.
  - SLL approved for Chile in May 2022.

### Milestones in monetary policy frameworks (context for independence)
- Cornerstone: A clear nominal anchor and a strong, credible commitment to price stability.
- Reforms and complementary measures:
  - Price stability placed at core of mandates, often supported by IMF technical assistance.
  - Fiscal reforms and government endorsement of central bank price stability objectives help mitigate fiscal dominance concerns.
  - Investments in regulatory, supervisory, and macroprudential frameworks support monetary authorities’ pursuit of price stability.
  - For inflation-targeting (IT) countries transitioning from fixed exchange rates: greater exchange rate flexibility and minimal foreign exchange interventions are critical to avoid perceptions of targeting specific exchange rate levels.
- Examples:
  - Bank of Thailand: adoption of IT supported by ambitious financial sector reforms.
  - Central Bank of Chile and South African Reserve Bank: strong commitment to exchange rate flexibility and limited FX interventions.
  - National Bank of Georgia: prioritized reforms to support development of its IT framework.
- Communications: Development of regular press conferences, policy statements, and monetary policy reports to enhance accountability and public understanding.

### Macroeconomic effects of undermining central bank independence (evidence from governor transitions)
- Data and classification:
  - Sample: 134 governor transitions in 11 advanced economies and 16 emerging markets since 2000.
  - Classification: Transitions coded by whether news reports mentioned political interference and political motive.
- Frequency:
  - Politically motivated transitions in emerging markets: 50 (about half of all transitions).
  - Politically motivated transitions in advanced economies: 5 (8 percent of all transitions).
- Correlation with inflation expectations:
  - Inflation expectations are less well anchored in countries with more frequent politically motivated transitions:
    - Expectations exceed targets by about 1 percent where such transitions are the majority.
    - Expectations exceed targets by over 2 percent where politically motivated transitions are the norm.
    - Expectations remain close to target in countries without political transitions.
  - No such relationship found with de jure measures of central bank independence (Romelli 2024).
- Causal effects (difference-in-differences local projections controlling for pre-trends and fixed effects):
  - Six months after politically motivated transitions, relative to countries with similar fundamentals that did not experience a governor transition:
    - Real rates fall by 1.6 percentage points.
    - Exchange rates depreciate by 3.1 percent.
    - Inflation and inflation expectations rise by 1.7 percentage points.
  - Exchange rate depreciation effect is reported but in some specifications not statistically significant.
  - Results for emerging market economies are very close to overall sample results; evidence for advanced economies is limited by small sample of politically motivated transitions.

### Key findings and statistics (explicit values preserved)
- Sample size for governor transitions: 134 transitions (11 advanced economies; 16 emerging markets).
- Politically motivated transitions:
  - Emerging markets: 50 transitions (about half).
  - Advanced economies: 5 transitions (8 percent).
- Inflation expectations deviations:
  - About 1 percent above targets where politically motivated transitions are the majority.
  - Over 2 percent above targets where such transitions are the norm.
- Six-month outcomes after politically motivated transitions:
  - Real rates: −1.6 percentage points (fall).
  - Exchange rates: +3.1 percent (depreciation).
  - Inflation and inflation expectations: +1.7 percentage points (rise).
- FCL/SLL announcement effect: spreads remain more than 20 basis points lower than synthetic counterparts in the 60 trading days following announcement.

### Policy implications and recommendations (derived from text)
- Protect central bank operational independence and limit scope for political interference to credibly anchor inflation expectations and ensure price stability.
- Complement monetary reforms with fiscal reforms and government endorsement of central bank price stability objectives to mitigate fiscal dominance risks.
- Invest in regulatory, supervisory, and macroprudential frameworks to support monetary authorities.
- For IT and transitioning countries, allow greater exchange rate flexibility and keep foreign exchange interventions to an appropriate minimum.
- Strengthen central bank communications frameworks (regular press conferences, policy statements, monetary policy reports) to enhance accountability and public understanding.
- Consider use of IMF precautionary instruments (FCL, PLL, SLL) for eligible countries to bolster market confidence and reduce spreads and capital-flow stress during risk-off episodes.

*International Monetary Fund | October 2025*

### CHAPTER 2 EMERGING MaRKET REsILIENCE: GOOD LUCK OR GOOD POLICIEs?

### CHAPTER 2 EMERGING MaRKET REsILIENCE: GOOD LUCK OR GOOD POLICIEs?

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*Source: CHAPTER 2 EMERGING MaRKET REsILIENCE: GOOD LUCK OR GOOD POLICIEs? (chapter bibliography).*

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_Source: https://www.imf.org/-/media/files/publications/weo/2025/october/english/ch2.pdf_