Most Emerging Markets Have Stayed Away From Outright Monetisation Of Deficits: IIF
Most emerging markets have stayed away from large scale quantitative easing of the kind that developed economies have undertaken.
The debate over government financing of increased expenditure amid collapsing revenue is not unique to India and is playing out across emerging markets.
So far, most emerging market economies, however, have stayed away from large scale quantitative easing of the kind that developed economies have undertaken, showed a research by the Institute of International Finance.
“Fiscal deficits around the world will widen sharply as the Covid-19 shock depresses tax revenue and creates temporary spending needs. Funding wider deficits will be relatively easy for reserve currency issuers and other DMs with moderate public debt,” a team of IIF economists led by Sergi Lanau wrote in a note dated June 2.
While developed countries have undertaken quantitative easing at an unprecedented scale, the situation is more complex in emerging economies where quantitative easing could depreciate currencies further and be potentially destabilising where currency mismatches are large, wrote Lanua.
An IIF study of select emerging markets showed relative restraint across these economies so far.
Indonesia
For Indonesia, the IIF projects a fiscal deficit of 6.5% of GDP.
Indonesia, which has a relatively open bond market, has seen a selloff by non-resident investors. Much of this, however, has been absorbed by the local financial system.
“A requirement to invest liquidity freed by a reserve requirement ratio cut in government bonds supported demand.”
Moreover, Indonesia has managed a net international bond issuance of around $3 billion, despite challenging global conditions. This shows the international market could be a significant source of funding for Indonesia, if needed.
“Given the pace of bond purchases by the local financial system through May, we think the chances of BI having to provide a substantial assist to fiscal policy are low. Even if foreign interest in government bonds remains subdued, financing the deficit should not require unusual policies,” the IIF said.
India
In India, the IIF projects a combined central and state deficit to reach 11.5% of GDP in FY21, the highest since the turn of the century.
As elsewhere in emerging market, foreigners reduced exposure to government bonds in the first few months of the year. Foreign presence in the Indian sovereign market, however, is minimal and will not drive the funding outlook.
“The parts of the domestic financial system we can track at high frequency absorbed significant amounts of bonds through April/May. As in recent years, we expect the government to rely on non-bond financing sources extensively, including the National Small Savings Fund. However, net bond issuance will still be sizeable,” the agency said.
The IIF expects structural demand for government bonds from the domestic financial system to remain high, making large-scale bond purchases by the Reserve Bank of India unlikely.
Brazil
In Brazil, where the IIF projects a deficit of 13% of GDP, the government has so far relied on using its deposits with the local central bank.
This operation does not involve new debt issuance but increases debt held by the private sector as the Brazlian central bank sterilises changes in government deposits by selling some of the government bonds it holds.
Eventually the central bank may have absorb some of the government bond issuance, the IIF said. “As in 2015-16, we assume the local financial system will be capable of absorbing many bonds in the context of low private credit demand. Unless government deposit drawdowns are larger than ever, we think the central bank will likely have to absorb some government bond issuance.”
South Africa
In South Africa, the IIF projects a fiscal deficit of 14% of GDP. Against this backdrop, foreigners have sold significant amounts of debt through April, it said.
So far, local banks have absorbed the incremental government debt issuance but eventually the central bank may have to step in.
“The split between the private financial system and the South African Reserve Bank is essentially a policy decision. Unless incentives are provided to the private sector to buy truly unprecedented amounts of bonds, the SARB may have to step in,” the IIF said.
Turkey
Turkey’s fiscal deficit is estimated at 5% of GDP, modest by current global standards.
Recent regulatory changes make Turkey a special case, the IIF said. “Banks bought very substantial amounts of government bonds through late May to meet new regulatory ratios, dwarfing sales by foreigners.”
As such, the IIF does not think much additional assistance from the Central Bank of the Republic of Turkey will be needed to finance the fiscal deficit.