“This time was different”, one may say about monetary policy responses to capital outflow shocks by emerging market economies (EME), as pointed out by a bulletin of the Bank for International Settlements (BIS) released on November 12th (Aguilar and Cantu, 2020). The pandemic-related global financial shock that occurred in March and April led to an exit of close to US$ 100 billion from EME – see Canuto (2020a) – and it was answered by local monetary authorities in ways different from previous episodes.
This time there was even the use of “quantitative easing” (QE) in some of them, that is, the expansion of the central bank balance sheet via acquisition of public or private securities as an additional monetary-financial management tool. Such asset purchase programs may either aim at simply stabilizing asset markets or easing financial conditions (with the term “easing” becoming more applicable in the latter case).
In financial shocks caused by outbreaks of capital outflow and currency devaluation, in the past, typically emerging central banks have been forced to tighten their monetary policies to halt the course. This time, in addition to facing a strong domestic economic slowdown, as a result of the health crisis and social distancing associated with Covid-19, the aggressive actions of liquidity provision by central banks in advanced economies facilitated a reaction in the opposite direction.
This time, EME central banks cut policy rates. compares interest rate policy reactions to the Covid-19 shock with what happened right after the 2008 global financial crisis and the EME stress period in 2015, when the end of the commodity price boom and a strong appreciation of the US$ sharply tightened financial conditions in EME . Having inflation expectations reasonably under control, besides the deflationary nature of the Covid-19 impact, policy rates were lowered as shown.
In addition to lowering interest rates, relaxing bank reserve requirements, using foreign reserves to dampen the exchange rate volatility, and term repo actions, 18 emerging countries have even launched public bond or private security purchase programs by their central banks (). QE has been for the first time used beyond advanced economies.
The latest IMF’s Global Financial Stability Report brought an assessment of the experience with the extended set of EME monetary policy tools. The report distinguishes three groups of EME where asset purchase programs were launched. In the cases of Chile, Poland and Hungary, for example, central banks were operating with interest rates already close to their lower bounds and, therefore, it can be said that they were in a similar position to the advanced economies where QE has become “conventional” (Canuto, 2020b). India and South Africa, with interest rates well above zero, did QE to improve the functioning of secondary bond markets. A third group, on the other hand, stated the intention to relieve interest pressure on government financing in the circumstances of the epidemic. Ghana and Guatemala, for example, had their central banks buying primary issuance of their public debt.
Other EME resorted to other ways of coping with the sudden liquidity drought and/or financing needs: Brazil, e.g. used cash buffers the Treasury had within the central bank’s balance sheet, while Mexico increased its external issuance and other Latin American countries engaged pension funds. Issuance was also backloaded to the extent of possible.
According to the IMF's assessment, the impact on domestic financial markets was overall positive, helping financial conditions to ease. Their effects were additional to the direct effects of domestic interest cuts, the indirect effects of the Federal Reserve's asset acquisitions and of an improvement of the global risk appetite from March onward. Arslan et al (2020), in turn, conclude that the actual market impact of asset purchases by EME central banks varied widely between countries, pointing to the roles played by initial conditions and how the measures were designed and communicated.
Where used, QE eased stresses in local markets and reduced rates - somewhere between 0.2 and 0.6 percentage points, according to the IMF report. And without being accompanied by devaluation pressures on exchange rates – which was helped by the fact that in several cases it corresponded to twist operations, with purchases of long assets being matched with sales of short ones and correspondingly some sterilization of the monetary impact.
The size of asset purchase programs was not high in most cases (Chile, Indonesia, the Philippines, and Poland were exceptions) and they were short lived (see ). They functioned as “circuit breakers”, signaling the central banks as buyers of last resort (Arslan et al, 2020).
QEs are more likely to succeed when monetary policy is effectively constrained by its lower bound, inflation expectations are grounded, risks of capital outflows and exchange rate depreciation are deemed low or the domestic absorption capacity of new bond supply is limited (). Asset purchase programs should be preferentially aimed at restoring confidence in markets rather than at simply providing monetary stimulus, let alone the monetary financing of fiscal deficits – paradoxically when they are more “quantitative stabilizing” than “easing”. Otherwise, they tend to lead to perceived risks of “fiscal dominance” – monetary policy captured by the objective of avoiding fiscal bankruptcy, rather than its own stability targets - or large-scale monetary easing, which would push bond yields up and exchange rates down.
To summarize, the pandemic global financial shock has sparked the inclusion of QE as a policy tool also available for central banks of EME. Nonetheless, the following caveats are worth being kept in sight:
· Except for when the acquisition of assets by central banks is for monetary financing of primary debt issuance, which is an issue on its own, QE targets are on the yield structures of interest rates. If there are fragilities leading to high basic, short-term interest rates, QE will not get much in terms of results. And the weight of transactions involving longer-term yields in EME is lower than in advanced economies
· QE should not raise concerns about “fiscal dominance”, because otherwise it will be self-defeating. Capital outflow pressures may exacerbate.
· A prolonged stay of central banks as buyers in local currency bond markets may distort market dynamics. A permanent role of the central bank as a market maker, especially in primary markets, will impair the development of the domestic financial market. Consideration should also be given to the effect of asset purchase programs on possible overvaluation of assets, as well as on collateral availability in the banking system and its impact on the policy rate transmission (Singh and Goel, 2019).
Quantitative easing is now part of the conventional toolbox of EME central banks. But it should not be taken as a magic wand.
Policy Center for the New South, a nonresident senior fellow at Brookings Institution, a visiting public policy fellow at ILAS-Columbia, and principal of the Center for Macroeconomics and Development. He is a former vice-president and a former executive director at the World Bank, a former executive director at the International Monetary Fund and a former vice-president at the Inter-American Development Bank. He is also a former deputy minister for international affairs at Brazil’s Ministry of Finance and a former professor of economics at University of São Paulo and University of Campinas, Brazil.