How did EMDE respond to the Coronavirus crisis?
Emerging market & Developing economies have employed a massive policy response despite limited resources
Covid-19 pandemic has been once in a lifetime event for all of us. It has produced a crisis like no other. Although the biggest fallout was seen in the Public health sector, the extended lockdown created an extremely challenging economic environment for countries around the world with business closures and massive layoffs.
While more developed countries with stronger balance sheets responded with massive stimulus packages to support the financial system, the real test came for emerging market and developing economies (EMDE) — a large group of countries, consisting of emerging markets and low-income countries.
They also stepped up to the plate to bolster not only the health services, but also extended unprecedented financial support to households, firms, and financial markets. Despite having limited monetary space and financial resources than some of the developed countries, they were able to provide much-needed relief to their economies.
Triggered by a ravaging pandemic, economic activity in EMDEs has decelerated at a historic pace — lowest in years. Several downgrades of these economies took place caused by a sharp decline in trade and capital flows, with the associated impact of an unprecedented decline seen in oil and other commodities. IMF has devised a useful Policy Tracker, that summarizes the responses of different countries to the COVID-19 pandemic.
Fiscal Policy Response
Like in developed countries, Fiscal policy measures have been at the forefront of the EMDE response — necessitating massive health spending along with massive financial support for the business sector and individuals. For the former, it came in the shape of loans, guarantees, and tax breaks to corporations and SMEs, while the latter received it in the form of extended unemployment benefits and subsidies on utility bills.
Although the size of fiscal support (7.7% of GDP) in Advanced economies dwarfed a similar response in emerging market economies (2.5% of GDP) & Low-income countries (1.2% of GDP), it was still a significant undertaking by EMDE to stabilize the financial system.
Monetary Policy Response
Most of the advanced economies and EMDE introduced prompt rate cuts & liquidity injections to ease credit stress in the markets. Since most of the central banks had little room to cut interest rates, they introduced unconventional monetary policy measures to keep the system afloat. One of them was the purchase of government and corporate debt.
100% of the advanced economies lowered their interest rates, the ratio was 74% and 78% in emerging markets and low-income countries respectively (Figure 2). Some countries relaxed lending and borrowing measures to ensure the availability of credit to the hardest-hit sectors.
Foreign Exchanges Rates
Flexible Foreign exchange rates of EMDE countries depreciated in response to outflow pressures and heightened risk aversion — by over 25% in countries like Brazil, South Africa, Seychelles & Zambia (Figure 3). To curb the resulting outflow of capital, many countries intervened in the Forex market by utilizing their foreign reserves and easing existing capital controls on inflows.
Among these more conventional measures, countries also employed other instruments to fight off the drastic financial impact of the pandemic, which included innovative digital solutions, better supply chain management and above all fostering an environment of International financial co-operation.
According to the G-20-led debt moratorium initiative, the IMF and other international financial institutions have promptly provided emergency assistance to more than 60 countries. To keep the liquidity flowing, the IMF also recently established a new Short-term Liquidity Line — part of its COVID-19 response to add to its lending toolkit. The U.S. Federal Reserve has also established new swap lines with central banks in several major advanced & emerging economies to ease the credit crunch.
The extraordinary policy response, bolstered by innovation and international cooperation is the right way forward in dealing with the rapidly changing situation resulting from the pandemic. Hopefully, we can negotiate these hard times with some valuable lessons learned.