BIS国际清算银行-Emerging-market-economy-exchange-rates-and-local-currency-bond-markets-amid-the-Covid-19-pandemic_9页_754kb

BIS Bulletin No. 5 Summary

Core Content

This BIS Bulletin analyzes the impact of the Covid-19 pandemic on emerging market economies (EMEs), focusing on exchange rates and local currency bond markets. It explores the financial vulnerabilities of EMEs, particularly how currency depreciation and capital outflows have interacted to worsen market conditions. The report also discusses the policy responses of EME central banks and the importance of sound monetary frameworks in mitigating these risks.

Main Points

1. Impact of the Pandemic on EMEs

• The pandemic triggered a global risk aversion that hit EMEs particularly hard.
• Local currency bond spreads and currency depreciation occurred simultaneously, indicating a strong link between exchange rates and financial market outcomes.
• Portfolio investors experienced amplified losses due to the synchronized movement of spreads and exchange rates, and their revised portfolio allocations further reinforced this correlation.

2. Original Sin Redux

• EMEs historically faced currency mismatches and maturity mismatches, which made them vulnerable to capital outflows.
• While EME corporates still rely on foreign currency credit, sovereigns have increasingly issued local currency bonds.
• Foreign ownership in EME local currency bond markets has increased, but this has also made EMEs more sensitive to global financial shocks.
• Exchange rate movements amplify the credit risk of EME bonds, as foreign investors are exposed to currency risk and yield risk simultaneously.

3. Procyclical Mechanism

• A depreciation of EME currencies against the US dollar leads to increased local currency bond spreads.
• This is due to the amplified credit risk and the exit of foreign investors.
• Empirical analysis shows that a 1% depreciation shock can lead to a 9 basis point increase in EME bond spreads.
• The 10% depreciation of EME currencies since early March could lead to a 90 basis point increase in spreads, though actual increases have been even higher.

4. Role of Policy Frameworks

• EME central banks have adopted policy frameworks combining inflation targeting, macroprudential tools, and FX reserve accumulation.
• These frameworks have provided stability to EMEs and should help them weather the financial fallout of the pandemic.
• FX reserves serve as a buffer against capital outflows and currency depreciation, reducing the impact of external shocks.

5. Policy Recommendations

• To manage large stock adjustments in domestic bond markets, EME central banks may need to expand their toolkit, including acting as a "dealer of last resort".
• This could involve targeted liquidity provision, repo market intermediation, or domestic bond purchases.
• EME central banks such as Colombia, the Philippines, Poland, and South Africa have already taken such steps, and more may follow if the market turmoil continues.

Key Information

• Graph 1 illustrates the sharp decline in portfolio inflows and increase in local currency bond spreads for EMEs during the pandemic.
• Graph 2 shows the correlation between foreign holdings and bond spread volatility, highlighting that higher foreign ownership leads to greater sensitivity to exchange rate movements.
• Graph 3 compares the sensitivity of EME bond returns in local currency versus US dollar terms, showing that US dollar returns are more volatile.
• Graph 4 confirms the procyclical relationship between currency depreciation and bond spreads, with data from 2013 and early 2020 showing similar patterns.
• Graph 5 highlights the growth of FX reserves in EMEs, which have buffered shocks and reduced financial stress.

Conclusion

The pandemic has exposed the vulnerability of EMEs to global financial shocks, particularly through the interplay of exchange rates and local currency bond markets. While foreign participation has helped grow these markets, it has also increased their sensitivity to currency fluctuations and portfolio shifts. Sound policy frameworks, including FX reserves and monetary policy tools, are crucial for mitigating these risks. EME central banks are adapting rapidly to the new environment, and expanding their toolkit may be necessary to stabilize their financial systems in the face of continued volatility.