## Employment, Growth and Emerging Markets – IMF F&D

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**Canonical URL:** [Employment, Growth and Emerging Markets – IMF F&D](https://www.imf.org/en/publications/fandd/issues/2021/06/emerging-markets-in-flux-pradhan-house-lubin)

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## Bibliographic details
- Authors: MAHMOOD PRADHAN
- Published: June 1, 2021

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### Resilience of emerging market assets during COVID-19
- Emerging market assets proved "remarkably resilient" over the past year despite pandemic shock.
- Contributing factors:
  - Very large liquidity injections from central banks in advanced economies.
  - Greater policy space in some emerging market economies, including use of unconventional monetary policies previously thought available only to advanced economies.
  - Increased diversification of the asset class: "more than 80 countries to choose from" versus a handful 25 years ago.
  - Ownership structure shift: "average ownership of foreigners is about 20 percent, including corporate debt."
  - Larger domestic ownership limits contagion and enhances resilience.
- Market behavior in 2020:
  - Eurobond issuance by emerging economy borrowers was some $800 billion for the whole of 2020, "more than a 10 percent increase over 2019."
  - Recession-induced reductions in current account deficits lowered external financing needs in many emerging economies.

### Interest-rate environment and potential risks when yields normalize
- Historical dynamics:
  - Collapse of US real interest rates starting in late March 2020 pushed capital toward emerging economies.
  - Rises in US interest rates have been a threat to emerging markets’ capital flows "since the 1970s."
  - A small recent increase in 10-year US Treasuries "caused some turbulence."
  - Persistent negative real yields on the 10-year US Treasury were described as "absurdly low"; as long as that remains the case, "the threat of significant capital outflows should be contained."
- Interactions with global growth:
  - If long-term rates move up because of stronger US growth, emerging economies generally lose more through capital outflows than they gain from increased exports under normal circumstances.
  - Contemporary global drivers: "the main driver of global investment trade and commodity prices has not been the United States, but China."
  - Ideal scenario for emerging markets: "a weaker US, with low interest rates pushing capital toward emerging markets, and a stronger China boosting trade and investment."
  - Policy developments in the United States (e.g., infrastructure plans) could help emerging countries, particularly if China refocuses toward consumption.

### Use of unconventional policies and policy space
- Unconventional monetary policy in emerging markets:
  - Many central banks in emerging markets used unconventional policies; "every central bank has been unconventional" compared with only a few years ago.
  - The narrative that emerging countries cannot do quantitative easing "is long past."
  - Diversity in approaches: example of India combining expansionary fiscal policy with caps on bond yields; such measures may not be viable in all countries due to potential for "massive capital outflows."
  - Effectiveness often depends on market confidence in growth potential and capital account openness.

### Debt burdens, default risk, and need for assistance
- Debt trends and concerns:
  - Debt burdens of emerging markets and low-income countries are "rising to unprecedented levels."
  - Many countries are unlikely to see debt-to-GDP levels return to pre–COVID-19 levels "for many years."
  - Accumulation of large debt in foreign currency is identified as "much more dangerous," though current indicators (external debt service ratio; debt to foreign exchange reserves ratio) "don’t look too stretched in historical terms."
  - Low US interest rates help keep debt service costs low.
  - Comparative historical point: past crises (1980s and 1990s) were linked to lack of dollar assets; in the last 20 years many emerging markets "made strenuous efforts to accumulate foreign currency reserves."
  - Domestic debt problems may be more serious in some countries; investors and the IMF have "very little experience" with domestic-debt crises.
- Default and restructuring:
  - Recent defaults/restructurings in Argentina, Ecuador, and Lebanon did not produce contagion.
  - Some countries facing liquidity or solvency issues will need more assistance from the IMF and "potential private sector participation in restructurings."
  - Private sector participation is warranted "when debt is clearly unsustainable."
  - The IMF's "lending into arrears policy" (first introduced in the 1980s) and private creditors’ risk assessment responsibilities were highlighted.

### ESG (environmental, social, governance) debt issuance opportunities and risks
- Market size and demand:
  - ESG-compliant borrowing in emerging markets is estimated at $16 billion, "still only 4 percent of total funds under management in emerging markets."
  - Demand from investors is strong; three-quarters of client meetings discussed ESG strategies.
- Roles and challenges for the IMF and public sector:
  - The IMF can help smaller countries get involved and support monitoring and reporting, given its commitment to the UN Sustainable Development Goals.
  - Suggested IMF roles: help with monitoring and engagement, especially on social and governance aspects; encourage country engagement and better reporting.
- Risks and caveats:
  - Money fungibility complicates assurance that proceeds fund stated green/social projects.
  - ESG ratings are "highly correlated to per capita GDP," raising concern that entrenched ESG-based capital allocation could produce perverse consequences and risk capital flows to lower-income countries.
  - Values-based investing could lead investors to exert pressure that may not always yield clear benefits and could "end up perpetuating a situation."

### Market structure and outlook
- Structural improvements reducing systemic crisis risk:
  - Pegged exchange rates are largely a thing of the past, reducing likelihood of another "big systemic emerging markets crisis" at the sovereign level.
  - Potential for crises remains at the corporate level in some countries.
- Private-sector differentiation and investor behavior:
  - Despite large-scale liquidity support, macro and political drivers "ultimately drive asset prices."
  - There has been "reasonable differentiation" across countries in sovereign credit and foreign exchange.
  - Portfolio managers are expected to perform proper risk assessments rather than rely on multilateral bailouts.

*Source: Employment, Growth and Emerging Markets – IMF F&D*

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_Source: https://www.imf.org/en/publications/fandd/issues/2021/06/emerging-markets-in-flux-pradhan-house-lubin_