ot long ago, emerging economies saw growth rates so high that economists predicted average incomes in developing countries would converge with those in advanced economies. Growth of this magnitude was attributed in part to the adoption of policies tried and proven by advanced economies.
During the Global Financial Crisis, for example, so-called unconventional monetary policies relieved liquidity stress. Decades before, inflation targeting helped break persistent inflation cycles. Liberalized trade policies sparked the hyperglobalization that initially enriched so many emerging economies.
Now, the International Monetary Fund (IMF) is observing a great divergence between rich countries—quick to vaccinate their populations—and poor countries, beset by unequal vaccine access, aging demographics, and decreasing productivity.
As advanced economies restart, meeting their demand for commodities, manufacturing, and semiconductors will prove challenging for virus-stricken emerging economies. Despite these hiccups in supply, advanced economies are regrowing quickly, which means central banks will soon attempt to manage that growth by raising interest rates. Once advanced world bonds are offering attractive yields with lower risk, investors will dump emerging market debt, depriving developing countries of the investment needed to finance their pandemic recoveries.
To staunch these outflows, emerging economies are also hiking short-term interest rates, offering higher yielding debt while simultaneously slowing an economic recovery that, absent large-scale vaccination, has scarcely started.
If their central banks are unwilling to raise interest rates, emerging economies could impose capital controls to stop investors, who may feel undercompensated for holding risky debt, from leaving the country. Developing countries normally limit capital flows to help stabilize their currencies. However, controlling their exchange rate regime now would complicate the latest policy tool adopted by emerging economies: quantitative easing.
Once the domain of advanced economies, for the first time central banks in India, Indonesia, and eighteen other emerging economies have purchased government bonds in order to ease financial conditions and lower long-term interest rates. Research suggests these countries have only avoided rapid inflation or currency depreciation because their governments issue debt in their own local currency and their central banks operate a floating exchange rate regime. Trying to mix quantitative easing with capital controls, then, may prove volatile.
So far, the experiment seems to be working because markets expect any bond-buying by central banks to be targeted and temporary. By increasing purchases or failing to taper them off, central banks risk the appearance of sacrificing their independence to finance their government’s agenda.
In a crisis, the temptation to elevate the role of central banks can be strong. Consider Colombia, which dabbled in quantitative easing and currently faces a debt-to-GDP ratio of 62%. When only seven percent of its population was vaccinated and economic conditions were languishing, President Duque floated a tax reform to pay for his government’s pandemic response. Citizens protested, demanding not just a repeal of the tax proposal but promises to prevent police violence, halt healthcare reform, and guarantee a minimum income. Voters now embrace a left-wing competitor who proposes Colombia’s central bank print more pesos.
Emerging economies cannot print their way out of debt without inflating their currencies, nor can they continue buying government bonds indefinitely without spooking investors. Yet India, Colombia, and many other developing countries have run out of room to ease financial conditions at home while also attracting investment from abroad. In such circumstances, quantitative easing can buy time for emerging economies to design a proper solution that meets the demands of their citizens—for stability, health care access, and social assistance—and their creditors, by maintaining conditions amenable to foreign investment and separating monetary policy from government finances.
But with COVID-19 cases rising and deficits ballooning, emerging economies are not positioned to pursue such a solution alone. Advanced economies are slowly shipping spare vaccines, but without foreign investment, emerging economy central banks will be pressured to fill the gap, sacrificing their own autonomy and credibility to finance their government’s unsustainable deficits. How else will emerging economies deal with their current debt load, totaling $24 trillion, or 250% of combined emerging economy GDP?
Warning of an impending debt crisis, the IMF proposes sustainable investment. One promising instrument is the so-called debt-for-climate swap. In the 1980s, thirty-nine countries used a similar instrument to restructure their debt by promising investments in biodiversity. Today, swapping short-term pandemic relief for long-term climate sustainability would allow emerging economies to responsibly finance a full recovery from the pandemic, invest in climate-resilient infrastructure, and participate in the transition to a low-carbon economy.
As private investors are clamoring for a variety of ESG products, President Biden has tasked America’s Development Finance Corporation with devoting at least one-third of its new investments to climate by 2023. Recognizing this demand, India issued a record amount of green bonds. Soon Colombia will attempt to cash in as well.
If convergence is still possible, emerging economies will need to face down the immediate COVID-19 crisis while also reckoning with the slower-burning crisis created by a changing climate.
Emerging economies—always vulnerable to the policies of advanced economy central banks—do not have much time. The Federal Reserve will soon taper its bond purchases and it’s keen to avoid another taper tantrum which, in 2013, drew rapid outflows from emerging markets. But if advanced economies do not voice their intent to support the recovery of emerging economies, capital will relocate—perhaps abruptly—and hamper the global recovery.
a global affairs media network
Will Emerging Markets Ever End Quantitative Easing?
Image via Pixabay.
September 7, 2021
A rapidly growing gap in COVID-19 vaccination rates between rich and poor countries means that emerging economies may be unable to restart, with potentially devastating implications amid rising inflation, writes YPFP Economics Fellow Carey Mott.
N
ot long ago, emerging economies saw growth rates so high that economists predicted average incomes in developing countries would converge with those in advanced economies. Growth of this magnitude was attributed in part to the adoption of policies tried and proven by advanced economies.
During the Global Financial Crisis, for example, so-called unconventional monetary policies relieved liquidity stress. Decades before, inflation targeting helped break persistent inflation cycles. Liberalized trade policies sparked the hyperglobalization that initially enriched so many emerging economies.
Now, the International Monetary Fund (IMF) is observing a great divergence between rich countries—quick to vaccinate their populations—and poor countries, beset by unequal vaccine access, aging demographics, and decreasing productivity.
As advanced economies restart, meeting their demand for commodities, manufacturing, and semiconductors will prove challenging for virus-stricken emerging economies. Despite these hiccups in supply, advanced economies are regrowing quickly, which means central banks will soon attempt to manage that growth by raising interest rates. Once advanced world bonds are offering attractive yields with lower risk, investors will dump emerging market debt, depriving developing countries of the investment needed to finance their pandemic recoveries.
To staunch these outflows, emerging economies are also hiking short-term interest rates, offering higher yielding debt while simultaneously slowing an economic recovery that, absent large-scale vaccination, has scarcely started.
If their central banks are unwilling to raise interest rates, emerging economies could impose capital controls to stop investors, who may feel undercompensated for holding risky debt, from leaving the country. Developing countries normally limit capital flows to help stabilize their currencies. However, controlling their exchange rate regime now would complicate the latest policy tool adopted by emerging economies: quantitative easing.
Once the domain of advanced economies, for the first time central banks in India, Indonesia, and eighteen other emerging economies have purchased government bonds in order to ease financial conditions and lower long-term interest rates. Research suggests these countries have only avoided rapid inflation or currency depreciation because their governments issue debt in their own local currency and their central banks operate a floating exchange rate regime. Trying to mix quantitative easing with capital controls, then, may prove volatile.
So far, the experiment seems to be working because markets expect any bond-buying by central banks to be targeted and temporary. By increasing purchases or failing to taper them off, central banks risk the appearance of sacrificing their independence to finance their government’s agenda.
In a crisis, the temptation to elevate the role of central banks can be strong. Consider Colombia, which dabbled in quantitative easing and currently faces a debt-to-GDP ratio of 62%. When only seven percent of its population was vaccinated and economic conditions were languishing, President Duque floated a tax reform to pay for his government’s pandemic response. Citizens protested, demanding not just a repeal of the tax proposal but promises to prevent police violence, halt healthcare reform, and guarantee a minimum income. Voters now embrace a left-wing competitor who proposes Colombia’s central bank print more pesos.
Emerging economies cannot print their way out of debt without inflating their currencies, nor can they continue buying government bonds indefinitely without spooking investors. Yet India, Colombia, and many other developing countries have run out of room to ease financial conditions at home while also attracting investment from abroad. In such circumstances, quantitative easing can buy time for emerging economies to design a proper solution that meets the demands of their citizens—for stability, health care access, and social assistance—and their creditors, by maintaining conditions amenable to foreign investment and separating monetary policy from government finances.
But with COVID-19 cases rising and deficits ballooning, emerging economies are not positioned to pursue such a solution alone. Advanced economies are slowly shipping spare vaccines, but without foreign investment, emerging economy central banks will be pressured to fill the gap, sacrificing their own autonomy and credibility to finance their government’s unsustainable deficits. How else will emerging economies deal with their current debt load, totaling $24 trillion, or 250% of combined emerging economy GDP?
Warning of an impending debt crisis, the IMF proposes sustainable investment. One promising instrument is the so-called debt-for-climate swap. In the 1980s, thirty-nine countries used a similar instrument to restructure their debt by promising investments in biodiversity. Today, swapping short-term pandemic relief for long-term climate sustainability would allow emerging economies to responsibly finance a full recovery from the pandemic, invest in climate-resilient infrastructure, and participate in the transition to a low-carbon economy.
As private investors are clamoring for a variety of ESG products, President Biden has tasked America’s Development Finance Corporation with devoting at least one-third of its new investments to climate by 2023. Recognizing this demand, India issued a record amount of green bonds. Soon Colombia will attempt to cash in as well.
If convergence is still possible, emerging economies will need to face down the immediate COVID-19 crisis while also reckoning with the slower-burning crisis created by a changing climate.
Emerging economies—always vulnerable to the policies of advanced economy central banks—do not have much time. The Federal Reserve will soon taper its bond purchases and it’s keen to avoid another taper tantrum which, in 2013, drew rapid outflows from emerging markets. But if advanced economies do not voice their intent to support the recovery of emerging economies, capital will relocate—perhaps abruptly—and hamper the global recovery.
