To fight the coronavirus, developing economies from Colombia to Indonesia are turning to a playbook that’s become familiar in the rich world since 2008: Central banks are buying government debt.
Since February, some 13 emerging-market central banks have started snapping up bonds or said they are considering doing so, according to research from Bloomberg Intelligence. It’s a policy that carries a whole extra layer of risk in countries where currencies are fragile and capital has a history of fleeing.
While the central banks are trying to stabilize turbulent financial markets, their actions are also providing support for bigger fiscal deficits, with public spending everywhere getting ramped up to shield people and businesses from the pandemic’s fallout. Some, like Bank Indonesia, are buying sovereign debt directly — taking a step further even than most developed-economy peers.
The danger for emerging markets, which often rely on short-term foreign capital, is that they’ll end up scaring it away — and reviving inflation — by flooding the system with newly created cash.
Already this year developing economies have seen outflows surpassing the 2008 global financial crisis, with Brazil’s real and Mexico’s peso among currencies to plunge more than 20 percent. Such losses in turn make it harder for governments and business to pay debts fixed in dollars.
In short, the risk is that these countries trigger a financial meltdown as they try to contain the economic one they’re already in.
“We can expect a larger number of emerging markets abandoning their fiscal straitjackets as the COVID cases mount and recession deepens,” said Chua Hak Bin, a senior economist at Maybank Kim Eng Research Pte. in Singapore. “Monetizing their fiscal deficits will risk a sharp currency sell-off, which can spark a deeper crisis given their dependence on external and foreign-currency financing.”
The economic pain from the virus could be especially severe in emerging markets, where swaths of the population work in informal jobs for meager pay without much of a social safety net.
Relief efforts are putting pressure on public finances, and there isn’t enough development aid to go around. More than 100 of the IMF’s 189 member countries have asked for help, the most ever. The Fund has doubled its quick-release loan programs to $100 billion, but it says emerging markets need to spend 25 times that much. Advanced economies haven’t come to the rescue: Former U.S. Treasury Secretary Larry Summers described their contribution as “crumbs off the table.”
Thrown back on their own resources, developing-world policymakers are trying to figure out how to maximize them — including by adopting versions of the policy known as “quantitative easing,” which blurs the lines between fiscal and monetary measures.
In India, for example, the budget gap may exceed 6 percent of gross domestic product this year, as the government tries to deliver supplies of staple foods to 800 million poor people, as well as cash transfers for women, senior citizens and farmers. And debate is raging over whether the deficit needs to be monetized — with former central bank chiefs weighing in on both sides.
The details vary widely, but the essential theme has been a feature of policy discussion in emerging-market capitals all over the world.
In Indonesia, the government recently abandoned a budget-deficit ceiling of 3 percent of gross domestic product — a restriction put in place in the aftermath of the Asian financial crisis more than two decades ago. The central bank last week made its first direct purchase of government bonds, pledging to be the “buyer of last resort.”
Thailand’s policymakers are studying unconventional steps like yield-curve control, a favored tool of the Bank of Japan. Brazil’s lawmakers have been debating a measure to expand the central bank’s bond-buying powers. In Chile, several former central-bank governors signed a letter supporting a constitutional amendment that would let the bank buy treasury notes.
Turkey’s central bank has been accelerating its purchases of debt since last month, in a process that’s been dubbed “Turkish QE” by analysts, as the government borrows more money to counter the effects of the virus.
Opponents of deficit-financing, like former Reserve Bank of India Gov. Duvvuri Subbarao, warn of credit ratings being downgraded to junk and a loss of credibility for the central bank. Several emerging markets have already had their ratings cut, including Mexico and Colombia, or are on watch for a downgrade, like Indonesia.
And signs of inflation or capital flight could force central banks to “tighten policy abruptly,” delivering a further blow to their economies, Bank of America analysts wrote last week.
There are some key differences between QE-type policies in advanced economies and emerging markets. In the former, the measures were first deployed to avoid deflation after interest rates hit zero. But in the latter, they’re more geared toward stabilizing markets, while there’s still room to cut rates in most cases — so unorthodox policy may be easier to withdraw.
On the other hand, while QE in advanced nations didn’t result in a pickup in inflation, that’s likely a bigger risk in emerging markets. There are already pockets of concern in countries like Turkey and India, and others could follow — even in a post-virus world of weak consumer demand.
Emerging-market central bankers will be well aware of the risks of overdoing their bond purchases. But right now, as they stare at the worst slump in generations, any such qualms are being set aside.
“Growth and immediate benefits to financial stability have taken priority relative to concerns over inflation and vulnerabilities to medium-term financial stability,” Carlos de Sousa at Oxford Economics wrote in an April 27 note. “The coronavirus crisis is changing the world fast, and monetary policy is no exception.”
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