How emerging European economies found a new monetary policy tool



The purchase of government bonds by central banks in emerging markets may be reminiscent of days of government monetary financing, which was often followed by rising inflation and currency depreciations. However, the successful actions of several central banks in emerging Europe to buy government bonds during the COVID-19 pandemic countered this story.

Amid the turmoil in financial markets at the onset of the pandemic, central banks in Croatia, Hungary, Poland, Romania, Serbia and Turkey rolled out Asset Purchase Programs (APPs), buying local currency bonds issued by governments but also by the private sector in the case of Hungary. New IMF research suggests that asset purchases in emerging European countries have helped alleviate dysfunctional financial markets, with no signs of destabilizing effects. With this goal achieved and to support the transmission of higher policy rates to the long end of the yield curve, central banks in emerging European countries should reduce or end asset purchase programs once the markets are over. tightened monetary policies.

Asset purchase programs in emerging Europe are distinct

Compared to APAs employed by central banks in advanced economies during the pandemic, most APAs in emerging European countries were smaller in size, although with significant differentiation within the region. They were also generally limited to the immediate period after the start of the pandemic, except in Hungary and Poland, where asset purchases continue.

The limited scale and duration of these FPAs is consistent with their objectives, which were to alleviate dysfunctional financial markets, provide liquidity, and repair the transmission mechanisms of monetary policy. This distinguishes these FPAs from quantitative easing used by central banks in advanced economies, which aimed to provide additional stimulus in the context of policy interest rates close to the effective lower bound. Indeed, FPAs in emerging European countries were for the most part implemented in parallel or even before the conventional easing of monetary policy. For example, Romania’s asset purchase program essentially ended in the summer of 2020, but the key interest rate did not hit its low of 1.25% until January. 2021.

Asset purchase programs have reduced pressure on the bond market

IMF research suggests FPAs in emerging European countries were successful in alleviating market dysfunction immediately after the pandemic shock. Using an event study approach, we find evidence that APP announcements have led to easing pressures on bond market liquidity and a reversal of surging futures spreads.

Importantly, we found no evidence that these APAs caused pressure on currencies. This may reflect their mostly limited duration and scope. In countries where FPAs were more extensive or prolonged, actions of central banks to absorb the additional liquidity created by these purchases may also have played a role in minimizing the impact on exchange rates. For example, the central bank of Poland issued its own securities, while the central bank of Hungary used a deposit facility to drain the liquidity created by the purchases.

Reduce or discontinue purchase programs for remaining assets

After successfully mitigating the initial market dysfunction, most APAs in the region have already been concluded. For the ongoing FPAs in Hungary and Poland, central banks are expected to examine the targets and their role in the tightening of monetary policy, which has already started in Hungary. Increases in policy rates should be accompanied by a decrease or removal of APAs, which would encourage the transmission of higher policy rates to the longer end of the yield curve.

In August, the National Bank of Hungary announced that it would start to gradually reduce its purchases of government bonds. While the National Bank of Poland has not yet raised its interest rates, the pace of purchases slowed down considerably from the spring months.

The future role of asset purchase programs

While APAs in emerging European countries have been successful during the pandemic and now appear to be part of the toolbox, the conditions under which to use them in the future are less clear. In part, their use may depend on global circumstances. It is important to recognize that the near universal easing of monetary policies during the pandemic has created more conducive conditions for emerging markets to use such tools. It remains to be seen whether FPAs could be used by emerging countries in response to idiosyncratic shocks without triggering reactions such as currency depreciation.

The fundamentals of the country are also important. One of the concerns about FPAs in emerging countries is that they could foster fiscal dominance if they help sustain deficits that cannot be financed by conventional means. A strong track record of macroeconomic stability and credible economic institutions are likely to alleviate concerns about fiscal dominance. To this end, the structure and discipline provided by EU membership makes these risks less acute, potentially increasing the future reach of FPAs in these countries.

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