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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.

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)
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
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
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.

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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.

India has limited exposure to external debt
India's external debt (% of GDP)
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Source: Pictet Asset Management, CEIC