Emerging and Frontier Markets: Policy Tools in Times of Financial Stress

IMF Blog, October 23, 2020

Source details

Canonical URL: Emerging and Frontier Markets: Policy Tools in Times of Financial Stress

Economic output in emerging market economies is projected to shrink by 3.3 percent in 2020.
Central banks across emerging markets responded swiftly and forcefully with an unprecedented response of their own, using a variety of policy tools to help stabilize markets and keep them functioning.
Nearly all central banks cut rates.
Most central banks intervened in currency markets.
About half of central banks cut reserve requirements for banks, which provided liquidity to the financial system and eased credit conditions.
Some 20 emerging market central banks for the first time launched quantitative easing—formally known as asset purchase programs—by buying government and private sector debt to alleviate stress and help keep markets functioning.

Asset purchases by emerging market central banks can be grouped into 3 main policy objectives:
- Central banks with policy rates well above zero tended to use asset purchases as a tool to improve bond market functioning (India, South Africa, Philippines).
- Central banks with policy rates closer to the “zero-lower bound” partially sought a course similar to advanced economy central banks, using quantitative easing to ease financial conditions and provide additional monetary stimulus, as well as for market functioning and liquidity objectives (Chile, Poland, Hungary).
- Some central banks explicitly stated that one of their objectives was to temporarily ease government financing pressure in the face of the pandemic (Ghana, Guatemala, Indonesia, and the Philippines).

After almost 6 months of quantitative easing in action, analysis suggests that these purchases had a generally positive impact on local financial markets.
The positive impact held even when accounting for policy rate cuts, additional large-scale asset purchases by the Federal Reserve, and the strong rebound in global risk appetite.
Specific effects observed:
- Asset purchases by emerging market central banks helped lower government bond yields without seeing accompanying depreciations in local currencies.
- Asset purchases gradually helped lower local market stress.

While asset purchases may be suitable for some central banks, policymakers should consider both benefits and potential significant costs.
Identified risks if asset purchases—especially if large-scale and open-ended—are used regularly:
- Institutional and central bank credibility may be weakened.
- Capital outflow pressure may intensify, especially in countries with weaker fundamentals.
- Concerns about fiscal dominance may arise among investors.
Implementation cautions:
- Transparency and clear communication are crucial to minimize risks to central bank credibility—especially in countries with weaker institutional frameworks.
- Purchases should preferably be made in secondary markets.
- Purchases in the primary market or at below market rates can affect the process of determining the fair price of bonds and can raise concerns that central banks will sacrifice their price stability mandated objective in order to finance the government (fiscal dominance).

Emerging market asset purchase programs can be helpful, but further evaluation is needed as more data become available on their effectiveness, especially if these purchases continue.
Lessons emerging so far:
- Asset purchases appear to be more effective when used jointly as part of a broader macroeconomic policy package.
- Asset purchase programs should, in most cases, be limited in time and scale and should be linked to clear objectives.
- Transparency and clear communication are essential to preserve credibility and manage risks.

Source: Emerging and Frontier Markets: Policy Tools in Times of Financial Stress (IMF, October 23, 2020).