Covid-19: Emerging Markets Like India Face Limited Policy Space, Stagnant Growth Risks, Says IIF
India is among those EMs where the QE debate is relevant but may remain theoretical due to the “fear of floating”: IIF
The U.S. enjoys an “exorbitant privilege” that gives it room to undertake very large stimulus measures. But for several emerging markets, such as India, depreciating currencies and rising bond yields severely limit governments’ policy space, says a report by the Institute of International Finance.
This dollar is at the root of this “exorbitant privilege”, the IIF explains.
- The Covid-19 shock has prompted a historic policy response in the U.S.
- Fiscal stimulus will likely take government debt from 80 to 110 percent of GDP.
- Meanwhile, unprecedented easing by the Federal Reserve is helping keep treasury yields at low levels.
What makes this aggressive policy response possible is the Dollar, which tends to rise in “risk-off” shocks, giving policy makers confidence that demand for U.S. assets will remain healthy, even with big increases in supply of government paper.IIF Paper: Covid-19 and EM Policy Space
Unfortunately, emerging markets do not enjoy this privilege. Most emerging market currencies fell due to the Covid-19 shock, even as local currency bond yields rose.
“This is one reason a debate has begun whether EM central banks should pursue Quantitative Easing,” says the IIF.
The paper classifies emerging markets into three subgroups:
- The first consists of close G-10 substitutes, such as Czech Republic, where quantitative easing is a practiced policy option.
- The third group carries the risk of large currency devaluation and even bigger risk premia in local currency bonds.
- The middle group is where the QE debate becomes relevant but may remain theoretical due to the “fear of floating”.
India is among that third subgroup, according to the IIF.
