Central banks in emerging markets have been forced to use unconventional tools to combat the impact of the Covid-19 pandemic, with the likes of Indonesia resorting to debt monetisation to offer the government some liquidity support. But market experts warn this may be a slippery slope.
Globally, central banks are trying to use every tool in their policy kits to shore up their economies and lessen the toll of the health crisis. While developed market economies have decent wriggle room to unleash novel ways to tackle the pandemic, developing countries have less freedom to do so.
“It was quite notable when Indonesia announced plans for debt monetisation,” Stephen Schwartz, head of Asia Pacific sovereign ratings at Fitch Ratings, told GlobalMarkets. “Many of the risks posed to macroeconomic stability and policy credibility associated with debt monetisation are more pronounced in emerging markets, and policymakers need to be very careful when it comes to market confidence and exchange rate pressures when they embark on this path.”
The Indonesian government has two kinds of agreements with Bank Indonesia (BI), Luky Alfirman, director general of budget financing and risk management at the ministry of finance, told GlobalMarkets in an exclusive interview ahead of the annual meetings.
“The first is the standby buyer agreement, where they will purchase governments bonds through the auction but at the market price. That is a different definition of debt monetisation.”
The second agreement — which is closer to debt monetisation — is where Bank Indonesia purchases government bonds through private placements without interest, he added.
“It is what we call burden-sharing — but it’s only intended to be a one-off,” he said. “BI can still purchase our bonds in the primary market next year, but we don’t expect the burden-sharing to continue.”
Unorthodox schemes
Alfirman added that almost all countries have adopted “unorthodox schemes” to respond to the crisis, while putting in place “huge stimulus packages”. “We have taken unprecedented steps, but the situation required it.”
Indonesia is not alone. The Philippines did something similar, with the central bank authorising the use of a repurchase agreement with the treasury to help meet the government’s urgent financing needs, said Schwartz.
This is expected to be unwound, but it did attract attention from investors. Other emerging market central banks have also been buying domestic bonds in the secondary market, including Thailand, Poland, South Africa, Croatia, Romania, Hungary, Chile, Costa Rica and Colombia.
In the cases of Croatia and Poland, large scale quantitative easing has been seen — rare for emerging market countries — in an attempt to lower rates. Croatia’s central bank, for instance, held 17% of domestic market debt, and Poland 13%, as of the end of May, according to a Fitch report.
But such measures can have big long-term consequences for countries — unless they are kept in check.
“Near-term rating implications are relatively minor, especially for countries like Indonesia with good track records of monetary policy management and low inflation, but medium-term implications are a concern,” said Schwartz. “If countries resort to these schemes repeatedly, it can undermine investor confidence, and lead to inflation and currency depreciation.”