Strategy Note /

Crisis economic policy response so far: constraint in small EM, FM

  • Burden on fiscal more than monetary policy in most EM, and deficits – which pre-date crisis – limit room for manoeuvre

  • Light fiscal responses: SA (large EM), Oman (oil exporters), Kenya, Philippines, Sri Lanka (oil importers), UAE (expats)

  • Heavy fiscal responses: Brazil (large EM), Qatar (oil exporters), Poland, Thailand (oil importers), Singapore (expats)

Crisis economic policy response so far: constraint in small EM, FM
Hasnain Malik
Hasnain Malik

Strategy & Head of Equity Research

Tellimer Research
13 April 2020
Published byTellimer Research

Most countries have now announced their economic policy responses (fiscal, monetary and FX) to Covid-19 and, in the case of oil exporters, to the oil price collapse too. Many have approached the IMF for financial assistance to combat Covid-19.

Below we compare fiscal and monetary responses across developed, emerging, and frontier markets. For EM and FM we also provide the context of how narrow, for most of them, is the room for manoeuvre.

Fiscal response and policy room

(1) Several countries have substantially increased their fiscal response from that first announced; eg the US and France in DM, Indonesia, Malaysia, Peru and Poland in EM, and Bangladesh, Georgia and Slovenia in FM.

(2) Very few countries are still to formalise any fiscal policy response; the main example in this context is South Africa.

(3) The range of fiscal response – defined as stimulus actions taken as a percentage of GDP – is very wide, with Japan (20%) in DM, Brazil (6.5%) in large EM, Hong Kong, Singapore, Qatar (10-13%) in small EM, and Iceland, Slovenia (8%) at the high end. See Figure 1 below.

(4) Developed markets: the fiscal response is generally much lower in Europe (with Italy at the lowest end at 1.4% of GDP) than globally (with US at 11.5% and Japan at 20%).

(5) Oil and commodity exporters: wide range in fiscal response, from negative 5% in Oman and negative 0.5% of GDP in Nigeria to positive 11-13% in Australia, Iran, Qatar.

(6) Oil importers: fiscal response in Kenya, Philippines, and Sri Lanka looks very small (all below 0.5% of GDP) compared to Bangladesh, Pakistan, Morocco (2-3%), let alone Georgia, Poland, Slovenia, Thailand (4-8%).

(7) Expat countries: wide range in fiscal response, from 2% in UAE to 9-13% in Hong Kong, Singapore, Switzerland.

(8) The space for fiscal policy response was tight before Covid-19 and the oil price crisis, with much of EM and FM running deficits wider than 3%. Following rate cuts real interest rates have narrowed, which reduces the space for further monetary easing (without causing pressure on FX reserves and the FX rate).

Below we illustrate the tightness of policy space using the average fiscal balance over 2020-21. These are based on the IMF's forecasts from October 2019, ie prior to the current crisis. (Of course, most of these forecasts are likely to materially deteriorate when the IMF updates its forecasts this month.) See Figure 2 below.

Monetary (interest rate) response and policy room

(1) Most countries have cut interest rates. See Figure 3 below. Across much of EM and FM, this has occurred in the context a policy rate easing cycle. Those with higher real interest rates before the crisis, have enjoyed the room for bigger policy rate cuts (eg Egypt, Ukraine).

(2) In addition to this, most countries have deployed a range of monetary and financial measures (eg asset purchases, temporary financing facilities for banks, interest and principal, payment deferrals for borrowers, lower capital buffers in commercial banks, restrictions on short-selling, reduction in mobile money transfer charges). 

(3) Similar to fiscal response, interest rates have been cut more than once in many countries; eg US in DM, Pakistan, UAE in small EM, Bangladesh in FM.

Below we illustrate the tightness of policy space using real interest rates (nominal policy rate minus inflation). In most of EM and FM these are already close to zero or slightly negative (in other words, without a significant further drop in inflation, there is a risk that hard-won anti-inflation credibility is eroded, in the event of further policy rate cuts). For some in EM, this credibility was already in question prior to the crisis (eg Argentina, Nigeria, Turkey). See Figure 4 below.

FX regime response and policy room

(1) Very few countries, thus far, have made formal changes to their FX regime although, anecdotally, we are hearing of more friction in repatriation in a range of smaller EM and FM; 

  • Kazakhstan has allowed FX depreciation but has limited the bid-ask spread, reduced the maximum for FX purchases without import documentation, and directed state-owned enterprises to sell down some of their FX reserves;
  • Nigeria has moved a step closer to unifying its multiple FX rates and devalued the official rate (previous import restrictions remain in place);
  • Morocco has widened the daily band in which its FX rate can vary;
  • Sri Lanka has introduced new restrictions for three months on outbound investment payments, commercial bank purchases of sovereign eurobonds, non-essential imports; and 
  • Zimbabwe has allowed the use of the US Dollar. 

[Note that Argentina has had various capital controls in place since August 2019.]

(2) However, many countries have been using their FX reserves to preserve orderly operations and/ or mitigate pressure on the FX rate; eg Brazil, Russia in large EM, Egypt, Peru, Thailand, Turkey in small EM, Bangladesh, Georgia, Iceland, Jamaica, Mauritius, Vietnam in FM.

Below we illustrate the vulnerability of FX rates in much of EM and FM with reference to the real effective exchange rate relative to the last 10-year average, with most FX rates above average. See Figure 5 below.

Cross-country comparison: a caveat when comparing across DM, EM, and FM

Because of the stronger starting point for most central banks (in terms of institutional credibility), FX (some of which are significant global reserve currencies), and greater formal financial inclusion (ie the interest rate is an effective transmission mechanism to the wider economy), the monetary response (interest rate and changes in financial facilities and regulation) tends to take on more of the burden of the policy response in DM and large EM. 

For example, in South Korea the fiscal response is merely 0.8% of GDP, whereas the package of financial stabilisation measures amounts to 5.3% of GDP. Therefore, a comparison of fiscal stimulus measures between two countries at very different stages of development is likely too simplistic.

Another example is the UAE, where the fiscal stimulus is merely 2%, the interest rate cut is 125bp but the overall package of softer banking regulations equates to 20% of GDP: reserve requirements from 14% to 7%, zero-interest collateralised loan to banks, use of excess capital buffers, lower provisioning for SME loans, higher loan-to-value for first-time house buyers, lower bank fees for SMEs, waiver for central bank service fees, real estate sector exposure limit of risk-weighted assets increased, loan-repayment deferrals for banks.  Of course, whether the customer base of expatriate corporates and consumers survives the economic shock to benefit from this softer banking regulation is a separate discussion.

For this reason, the cross-country comparison of fiscal policy alone is more meaningful within the small EM and FM universe.

Get of jail cards: globally coordinated debt relief or much larger assistance from the IMF

This analysis precludes external debt relief across EM and FM which would impact the room for manoeuvre for policy makers, particularly when it comes to fiscal response (savings on debt servicing) and FX rate (relief on FX reserve burn).

The funding facilities from the IMF to counter Covid-19 specifically, may end up being made available in sufficient quantities, quickly enough, and at a low enough cost to offset some of the initial economic shock from Covid-19. However, given the IMF's likely insistence that the use of these funds is very narrowly defined, this will not help with second-round effects from, for example, social distancing (business closures, job losses, poverty). And, of course, these facilities have no bearing for most of the oil exporters, where the Covid-19 crisis has been compounded by the oil price collapse.

Related reading

Waiting on the world to change: Politics, economics, business and EM post-crisis (pp19-21)

EM-FM Equity Strategy: The courage to change nothing (pp15-16)

IMF emergency financing tracker: 90 requests so far

Seychelles: Canary in the coal mine

IMF/WB call for debt standstills: further thoughts and implications for bonds