Until very recently, bond buying by central banks was a phenomenon limited to the world’s largest and most advanced economies. As the Covid-19 crisis has deepened, however, policymakers in smaller and less developed markets have taken a leaf out of their book.
The epicentre of this new trend is central and eastern Europe. Recently, central banks in Poland, Romania, Croatia and Hungary have all bought local government bonds in the secondary market. The Czech National Bank (CNB) has said it may follow suit.
Inevitably, these initiatives prompted some observers to hail the arrival of quantitative easing (QE) in CEE. Were they correct?
No, says Liam Peach, CEE analyst at Capital Economics.
“The QE programmes we’ve seen in advanced economies since 2009 were purely intended to reduce and flatten the yield curve when short-term interbank rates became so low that central banks were unable to use them as a policy tool,” he says.
That is not the case in CEE. Even after several recent rounds of rate cuts, none of the non-eurozone economies in the region is at the zero bound. The closest is Poland, which slashed its benchmark rate to 0.5% on April 8.
Equally, there is no urgent need to inject liquidity into CEE banking sectors.
Dan Bucsa, chief economist for CEE at UniCredit, notes that most banks in the region went into the crisis cash-rich and have access to additional liquidity via repos.
Rather, he adds, the recent rounds of bond buying by CEE central banks were designed to stabilize local government bond markets during the global sell-off sparked by the Covid-19 outbreak.
“When outflows started from emerging markets, local investment funds in some of these countries were struggling to gather cash,” says Bucsa. “Providing liquidity through the secondary market was a way to alleviate this pressure.”
In these terms, the relatively limited bond buying programmes undertaken in the first weeks of the Covid-19 crisis proved effective. Yields in Poland and Romania have stabilized since mid March. Bond purchases also took some of the pressure off exchange rates, particularly in Romania.
So far, so good. Few analysts, however, believe that it will end there. With further rate cuts expected across the region, most believe that central banks will sooner or later take advantage of their expanded toolkit.
“As and when central banks in CEE reach the zero-lower bound, they are likely to quickly shift from bond purchases as a liquidity-providing tool towards quantitative easing as a monetary easing tool,” says Peach.
Indeed, he adds, this is effectively what Poland’s central bank is now doing, following an expansion of its bond-buying programme in early April.
If CEE central banks do turn to large-scale QE, the impact on currencies would be pretty negative, and this may encourage them to tread more cautiously- Liam Peach, Capital Economics
This could prove more problematic. To date, QE has only been used on a large scale in countries with strong currencies and deep pools of demand.
Gunter Deuber, RBI
As Gunter Deuber, head of research at Raiffeisen Bank International, notes: “Everyone needs some exposure to euros, so whatever the European Central Bank does there will always be buyers for eurozone bonds.
"In small markets, and ones where non-residents can push the fire button from one day to the next, QE will be a much more challenging prospect.”
Currencies in CEE are already under pressure.
Romania’s central bank has intervened to support the leu in recent weeks, and the CNB has expressed a willingness to follow suit. In Hungary, pressure on the forint prompted policymakers to raise two key rates on April 7.
“If CEE central banks do turn to large-scale QE,” says Peach, “the impact on currencies would be pretty negative, and this may encourage them to tread more cautiously.”
As governments in the region step up support for citizens and businesses hit by the Covid-19 crisis, however, that tool could become a double-edged sword. Stimulus packages will need to be financed – and for most CEE finance ministries that will mean turning to the local bond markets.
The question then is who will be on the buy side at a time when global investors have lost their appetite for emerging-market local-currency debt.
Policymakers in Romania and Hungary would like to see banks step up their purchases of government bonds. While they may be able to persuade or corral lenders with local capital, however, the subsidiaries of western European banks will be constrained by the ECB’s relatively harsh treatment of non-eurozone sovereign risk.
We will likely see the central banks in the market for as long as needed- Dan Bucsa, UniCredit
That will put the onus on local funds, which will almost certainly be unable to provide the requisite volume of financing without central bank support.
“We will likely see the central banks in the market for as long as needed,” says Bucsa. “They may not buy directly, but they will look to mop up bonds from the secondary market to free space for local investors and make the market more attractive for foreigners.”
Whether this will be possible without putting undue pressure on local currencies remains to be seen. Still more worrying, in countries with less fiscal space and weaker institutions, is the prospect of QE segueing into direct deficit monetization.
In CEE, analysts are particularly concerned about Romania, which was already facing a budget squeeze before the start of the Covid-19 crisis after three years of over-spending by the Social Democratic Party (PSD) government before its ousting in October.
“Romania has a huge refinancing challenge this year, and it’s mostly on the local market,” says Deuber.
On the upside, Romania’s central bank has so far managed to remain independent despite repeated attacks by PSD politicians. Some observers worry, however, that the coronavirus crisis could give its opponents the opportunity they have been waiting for.
By contrast, Poland boasts a strong fiscal position but a politicized central bank.
“If large-scale bond purchases are used over a prolonged period in CEE, that could create concerns about central banks’ credibility, particularly in Romania and Poland,” says Peach.
Even if central banks stick rigidly to orthodox QE, however, Peach questions its relevance and applicability in CEE.
“Before the coronavirus crisis, the biggest support for growth in these countries was from labour markets,” he says. “Measures to restore the health of the labour market and provide support to businesses are likely to be most effective at boosting growth.
“The type of crisis CEE is facing would suit itself to a larger fiscal response than a monetary response.”