CHAPTER 4 ASSET PUCHASES IN EMERGING MARKETS Unconventional Policies, Unconventional Times GLOBAL ECONOMIC PROSPECTS | JANUARY 2021 C H AP T E R 4 171 Central banks in some emerging market and developing economies (EMDEs) have employed asset purchase programs, in many cases for the first time, in response to pandemic-induced financial market pressures. These programs, along with spillovers from accommodative monetary policies in advanced economies, appear to have helped stabilize EMDE financial markets. However, the governing framework, scale, and duration of these programs have been less transparent than in advanced economies, and the effects on inflation and output in EMDEs remain uncertain. In EMDEs where asset purchases continue to expand and are perceived to finance unsustainable fiscal deficits, these programs risk eroding hard-won central bank operational independence and de-anchoring inflation expectations. Ensuring that asset purchase programs are conducted with credible commitments to central bank mandates and with transparency regarding their objectives and scale can support their effectiveness. Introduction stabilize financial markets and improve market functioning during periods of high volatility and The COVID-19 pandemic has tipped the global low market liquidity, an objective that did not economy into its deepest recession since the motivate the early advanced economy asset Second World War. To stabilize financial markets purchase programs (Christensen and Gillan 2019). and support activity, many central banks have employed asset purchase programs—often for the Central banks across advanced economies and first time in the case of emerging market and EMDEs have responded to the economic and developing economies (EMDEs). These have financial market shocks induced by the COVID- involved outright central bank purchases of 19 pandemic with broad-based cuts in short-term longer-term financial assets, usually government policy rates, which in many economies are now at, bonds, and corresponding injections of reserve or close to, their effective lower bounds. One-third money into the banking system. This chapter of advanced economy central banks have reduced explores how EMDE asset purchase programs their short-term policy rates to 0 percent or lower, have evolved, and assesses their potential benefits while around 90 percent have lowered them below and costs. 1 percent (figure 4.1). Some EMDE central banks (Chile, Costa Rica, Hungary, Paraguay, Peru, The purchase of longer-term assets by central Poland, Thailand) have also cut policy rates to less banks has both complemented and substituted for than 1 percent. For additional policy easing and to other monetary policy tools. This instrument has contain a sharp rise in government bond yields in primarily been used in advanced economy March 2020, many of these central banks “quantitative easing” programs with the aims of introduced asset purchase programs (Chile, Costa stimulating demand, boosting output, and raising Rica, Hungary, Poland, Thailand). Policy rates inflation toward targets. Purchases of longer-term remain above 1 percent in 80 percent of EMDEs, assets have usually been employed when the limits but central banks in at least 13 of these EMDEs of conventional monetary policy tools have been have also implemented asset purchase programs reached—in particular, when short-term monetary (figure 4.1). policy rates have fallen near their effective lower bound. Asset purchases can directly influence This chapter addresses the following questions: specific financial market segments and asset maturities, and longer-term asset purchases can • How have asset purchase programs been serve to lower long-term interest rates, which designed in EMDEs? would be only indirectly impacted by conventional monetary policy tools (Haldane et al • Have EMDEs benefited from these programs? 2016). These programs can also be used to help • What are the risks associated with these programs? Note: This chapter was produced by Jongrim Ha and Gene Kindberg-Hanlon. Research assistance was provided by Kaltrina • What are the main policy lessons for EMDEs? Temaj and Jingran Wang. 172 C H AP T E R 4 GLOBAL ECONOMIC PROSPECTS | JANUARY 2021 FIGURE 4.1 Policy interest rates and bond yields Contributions. This chapter contributes to the In 2020, central banks in advanced economies cut policy rates close to the literature in three ways. effective zero lower bound. Toward the end of the year, around 90 percent of advanced economy policy interest rates were below 1 percent, and one- First, it takes stock of the EMDE asset purchase third were at or below zero. In contrast, just 20 percent of EMDE central banks have cut policy rates below 1 percent. In addition to policy rate cuts, programs that have been announced or many advanced economies and EMDEs initiated asset purchase programs implemented since early 2020. It discusses how after government bond yields, including those usually considered “safe- the programs in EMDEs compare to those in haven” assets, spiked in March 2020. advanced economies in their design, scale, and objectives. To shed light on the topic, the chapter A. Advanced economy policy rates B. EMDE policy rates also presents a review of the literature on the macroeconomic and financial effects of programs in advanced economies, including their spillovers to EMDEs. Second, the chapter is one of the first studies to provide detailed evidence on the effects of asset purchase announcements in EMDEs on financial markets. A few earlier studies have estimated the impact of asset purchase program announcements C. Distribution of policy rates: D. Distribution of policy rates: EMDEs Advanced economies in EMDEs on bond markets and exchange rates (Arslan, Drehmann, and Hofmann 2020; Hartley and Rebucci 2020; IMF 2020b). This chapter expands on these studies by including the effects on equity markets and by comparing the effectiveness of EMDE asset purchases to that of conventional monetary policy actions, and that of asset purchase programs in advanced economies. Third, the chapter reviews historical experiences of E. Peak increase in bond yields and F. Advanced economy and EMDE central bank financing of government deficits in spreads in March 10-year government bond yields EMDEs. In particular, it reviews the circum- stances of economies that experienced episodes of debt monetization and high inflation in the 1980s and early 1990s and draws out parallels and differences with the central bank policies and country circumstances of those EMDEs undertaking asset purchases in 2020. It assesses the circumstances—in particular elevated levels of debt, large fiscal deficits, and weak growth prospects—which may increase the risk that some Sources: Haver Analytics; National sources; World Bank. Note: EMDE = emerging market and developing economies; EMBI = JPMorgan Emerging Market EMDEs begin to resemble these historic episodes. Bond Index. A.-D. Data for up to 16 advanced economy and 67 emerging and developing economy central banks during 2000-2020. Findings. Several findings emerge from this A.B. Solid line reflects a simple average of policy rates. Shaded region shows the inter-quartile range. chapter. E. Maximum increase in local currency government bond yields and the JPMorgan EMBI index of EMDE foreign-currency bond spreads during March 2020 using daily data. Orange whiskers indicate the maximum and minimum increase in 10-year government bonds in 30 advanced economies and • 21 EMDEs. Bars indicate the average increase. Diverse design of asset purchase programs in F. Average of 10-year government bond yields for up to 30 advanced economies and 22 EMDEs. As of mid-December 2020, 18 Click here to download data and charts. EMDEs. EMDEs had announced or implemented asset purchase programs. Asset purchases have GLOBAL ECONOMIC PROSPECTS | JANUARY 2021 C H AP T E R 4 173 been mainly focused on local currency- before it, asset purchase programs have helped denominated government bonds. The size of reduce bond yields and boosted equity prices asset purchases has varied from less than 1 to 6 during periods of market illiquidity in percent of GDP. Many EMDE central banks EMDEs. The recent experience of asset pur- have not announced the scale or duration of chase programs, however, may overstate its purchases, and while most have been pur- future effectiveness for three reasons. First, it chasing only in secondary markets, some have was set against the backdrop of uniquely purchased bonds directly from governments. accommodative macro-economic policies in advanced economies. Second, it was an • Decline in government bond yields. Announce- unanticipated departure from earlier policy ments of asset purchase programs appear to guidance of EMDE central banks that had have helped stabilize bond markets and boost focused on buttressing their independence. equity prices without putting pressure on Third, fragile liquidity conditions in EMDE exchange rates. The effects on long-term bond financial markets are conducive to volatile yields and equity prices have been on average movements in asset prices, possibly leading to greater than the effects of the announcements unintended consequences of future asset of monetary policy rate cuts in response to purchases. COVID-19. In addition, the announcement effect of EMDE asset purchases on • Policy implications and design of asset purchase government bond yields (but not equity programs. Embedding asset purchase programs prices) seems to have been larger than the in a transparent