The "invisible hand" of advanced country central banks in emerging markets
By: Piroska M. Nagy Senior Adviser to the Chief Economist
We all know that most emerging market economies have limited policy room to deliver massive counter-cyclical crisis response. This affects their risk perception, investor confidence, and capital inflows. Indeed, most emerging markets have limited fiscal space (except for those with a war chest of international reserves such as China and several other Asian countries, or Chile in Latin America). Untraditional monetary policy/quantitative easing is constrained by concerns over the possible impact of large liquidity injections on exchanges rates in the context of weak market confidence.
However, there is an invisible channel through which advanced country quantitative easing can benefit emerging markets. Through advanced country based international banking groups, quantitative easing in those countries has been quietly trickling down to subsidiaries of these bank groups in emerging markets. This is true for subsidiaries of large US-based banks in Latin America or Asia, or of large euro-zone based international banking groups.
This “invisible hand” of the European Central Bank is particularly important, given that Europe appears to have the highest propensity among regions to do cross-border lending (see below chart). In the euro zone, ECB refinancing rates have been slashed. Eurobor interest rates have also come down dramatically from about 5.5 per cent just nine month ago to 1.5 per cent. Parent banks can obtain funds at these rates and use it for their whole bank group. The extent to which this benefits their subsidiaries depends on the risk pricing parent banks attach to exposure to their subsidiaries that are located in a region which has been subject to heavy downgrades. Risk pricing is based on prudential considerations as well as strategic decisions. Some bank groups may charge below CDS levels, others apply CDS – and actually can make good profit on it, particularly where domestic policies are generally appropriate and international support is overwhelming. Be it as it may, this has helped strategic bank groups to stay engaged in the battered emerging European markets. Moreover, as a smart banker pointed out to me the other day, under pegged currency arrangements, the lower euro cost funding may outweigh the impact of higher risk premium for a given country, leading to a significant decline in the nominal value of debt service. This can help unhedged borrowers – particularly those with young exposures where the interest payment portion is larger – to cope with necessary real adjustments through nominal income decline in the context of the pegged arrangements of Latvia and others.
(Source: IMF)
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Tags: central banks > ECB > emerging markets > European Central Bank > Latvia
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June 4th, 2009 @ 11:35 am
Your earlier post with Stefan Knobloch, on cross-border flows, was excellent and very worrying: $57bn outflow concentrated in half a dozen countries of Emerging Europe, and more in Q1 2009, can do a lot of damage. The “Invisible Hand” of the European Central Bank does nothing to reassure me. The ECB hand is invisible because it is not there.
The ECB is notorious for not having the function of Lender of Last Resort, which rests with the national Central Banks for their national banks, leaving open the thorny and often unanswerable question of bank nationality. The ECB is often said to have functions of ELA – “Emergency Liquidity Assistance”, understood as lesser responsibilities than those of Lender of Last Resort – except that these are informal and discretionary, although the IMF uses LLR and ELA interchangeably.
Anywat, quantitative easing does not seem to work well in the Eurozone, as banks are still reluctant to lend; why should liquidity trickle down into Emerging Europe. I have heard of trickling down before, but I have also come across trickling up. Quantitative easing by the ECB and national Central Banks in Europe is much more likely to spill-over into a commodity price boom than into Emerging Europe. (For a fuller discussion see http://dmarionuti.blogspot.com/2009/06/ebrd-and-foreign-banks-in-transition.html)