EM Monitor - Emerging markets' response to the economic crisis
April 2020
QE in emerging markets - A new era?
In the face of the current economic crisis, emerging markets (EM) are turning to QE for the first time. Our economists look at the measures announced so far and the associated risks.
Written by
Anjeza Kadilli, Senior Economist
Kiran Nandra, Senior Product Specialist
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One of the effects of the Covid-19 crisis on EM economies has been the sharp rise in credit spreads (See Fig. 1). Central banks have reacted with the introduction of different measures, including QE, which is unprecedented for EM.
Widening EM spreads shows the magnitude of the shock
Fig.1 - EMBI spread level and change since early February (basis points)
Source: Pictet Asset Management, Bloomberg, data as at 08.04.2020
EM central banks stepping into unchartered territory
Chile, Colombia, the Czech Republic, Hungary, Indonesia, Israel, the Philippines, Poland, Romania and South Africa have announced QE measures to tackle the current economic crisis (see Fig.2).
Others are considering similar measures. In Brazil, it requires a modification of the country’s constitution, illustrating the exceptional character of these measures in the EM space.
EMs announcing diverse QE programmes
Fig.2 - Summary of QE programmes in Emerging Markets
Source: Pictet Asset Management, relevant central banks’ websites, 08.04.2020
What makes EM QE different?
In developed economies, QE has been used as a tool to lower the cost of funding once conventional tools were exhausted.
While the amounts are limited, the symbolic is strong
In EMs by contrast, the objective of the measures is to improve liquidity and keep markets functioning. The amounts associated to EM QE programmes so far remain limited, especially relative to GDP, but the symbolic of these measures is strong.
In the current scenario, most of the countries will combine QE with conventional tools.
QE used in conjunction with policy rate cuts
Most EM central banks have already cut their policy rates (see Fig. 3).
EM central banks cut rates by up to 1.25% since February
Fig.3 – Monetary policy rate and change since early February
Source: Pictet Asset Management, Refinitiv, CEIC, Bloomberg; data as at 08.04.2020
Additional measures & the Philippines example
Additional measures include targeted longer-term refinancing operations, a cut of the reserve requirement ratio and other tools to improve liquidity.
The Central Bank of the Philippines is a good example. After two rate cuts of 25 and 50 basis points in February and March respectively, it announced a repurchase agreement of government bonds from the Treasury. It also slashed the Reserve Requirement Ratio (RRR) for universal and commercial banks from 600 to 400 basis points. It is exploring a similar cut for other banks and financial institutions. It has also remitted PHP 20 billion as advanced dividend to the central government to fight Covid-19.
QE in Emerging Markets – Testing central banks’ credibility
The new QE programmes will test the faith investors already have in central banks.
Beyond the objectives of helping the smooth functioning of markets, maintaining liquidity, reducing financing cost for governments and firms and helping raise inflation if appropriate (which is not the case for most), EM central banks are exposing themselves to a real test of credibility.
The first test will be to clarify the size and duration of these QE programmes, which are rarely specified.
The first test for central banks will be the definition of clear conditions.
Their credibility will also depend on their independence from governments.
QE will likely lead to inflationary pressures where measures are financed by money printing and long-lasting. It could also lead to an artificial increase in asset prices, beyond those assets targeted by the measures. Here again central banks will need to demonstrate careful management of these side effects.
One advantage for EMs is that QE is more efficient if the policy rate is not in the zero-lower bound, which is the case for most as illustrated in Fig. 3.
Drastic times call for drastic measures. In response to the Covid-19 crisis, EMs are introducing QE measures for the first time. These present short-term benefits but also long-term drawbacks if not well managed. They will be a real test of central banks' credibility.
THE VIEW FROM OUR EMERGING MARKETS EQUITY TEAM
By Kiran Nandra, Senior Product Specialist
Like the EM central banks referred to in the above section, the Reserve Bank of India (RBI) has announced a 75 bps rate cut, a temporary moratorium on loan repayments and a cut in the RRR.
But can the RBI do more if needed?
We believe the answer is yes. There’s often a balancing act between QE and the currency. In India’s case, the rupee has held up relatively well, which is good news given EMs' historical reliance upon dollar-denominated debt. What’s more, India is minimally exposed on this front with a highly manageable external debt/GDP ratio of c. 20 per cent (see chart below).
Our focus remains on companies with strong fundamentals. The recent sell-off and uncertainty are also providing opportunities, such as consumer names which have historically been too expensive but that now look attractive.
Laurent Nguyen, Head of Quest Equities, Gabriele Susinno, Senior Client Portfolio ManagerFebruary 2020
About
Anjeza Kadilli
About
Anjeza Kadilli
Anjeza Kadilli joined Pictet in 2015. She is an Senior Economist in Pictet Asset Management’s Economic Analysis team where she conducts macroeconomic analysis of emerging markets. Anjeza holds a PhD in Econometrics from the University of Geneva - where she also obtained an MSc and BSc in Economics. During her PhD, Anjeza spent time at the University of Southern California, Riksbank and HEC Montreal as a visiting scholar.
About
Sabrina Khanniche
About
Sabrina Khanniche
Sabrina Khanniche joined Pictet Asset Management in 2011 as an Economist in the Fixed Income team. Before joining Pictet, she was with Groupama Asset Management during four years as a Financial Engineer in charge of the analysis and modelling of hedge fund risks. In this regard, she published and presented her work in international academic conferences. Sabrina holds a Master and a PhD in Economics from the University of Paris West Nanterre La Défense.
About
Nikolay Markov
About
Nikolay Markov
Nikolay Markov joined Pictet Asset Management in 2013 as an Economist in the Fixed Income department.
Before joining Pictet, he was working in the Monetary Policy Analysis Unit of the Swiss National Bank where he performed research on monetary policy rules for Switzerland. Prior to working at the Swiss National Bank he was a teaching and research assistant at the University of Geneva and participated in international academic conferences.
Nikolay holds a PhD in Economics from the University of Geneva and obtained a PhD program certificate from the Swiss National Bank doctoral institute in Gerzensee.
About
Lola Saugy
About
Lola Saugy
Lola Saugy joined Pictet Asset Management in 2018 as part of the firm’s Graduate Programme. She is now a Quantitative Economic Analyst within the Economic Analysis team in Geneva. Lola holds a Master of Science in Applied Mathematics from the Ecole Polytechnique Fédérale de Lausanne. She did her master thesis at Harvard University in the field of biostatistics, as a visiting scientist.
About
Kiran Nandra
About
Kiran Nandra
Kiran Nandra joined Pictet Asset Management in 2016. She is a Senior Product Specialist for the Global Emerging Markets Equities team.
Previously, Kiran worked at Wellington Management where she was most recently a Portfolio Specialist. She joined Wellington in a Relationship Management role before becoming a Research Analyst covering European and Latin American banks.
Kiran graduated from University College London with an LLB (Honours) degree in Law.
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