Emerging Market Monetary Policy and Currencies
Sources: Bloomberg Finance L.P.; EUROPACE AG/Haver Analytics; IMF, World Economic Outlook database; national sources; and IMF staff calculations. Note: Panel 2 uses six-week averages. In panel 3, carry factor includes both interest rate differential and a global carry factor. The construction of the global carry factor and the dollar factor follows Verdelhan (2018), using a portfolio of 16 EM and 9 advanced economy currencies. The decomposition is based on a rolling regression over 18 months. Panel 6 reports spillovers from changes in US term premiums to EM term premiums. Specically, the measure of spillovers reported here—using the methodology proposed by Diebold and Yilmaz (2009)—is the proportion of variation in EM term premiums that can be explained by shocks emanating from US term premiums. EMs include 15 countries accounting for about 76 percent of total EM GDP. The spillovers shown here correspond to a 100-week rolling window. Data labels in the gure use International Organization for Standardization (ISO) country codes. BRL = Brazilian real; CEEMEA = Central and Eastern Europe, the Middle East, and Africa; CLP = Chilean peso; CNH = Chinese renminbi; COP = Colombian peso; EM = emerging market; EMEA = Europe, the Middle East, and Africa; FX = foreign exchange; GFSR = Global Financial Stability Report; HUF = Hungarian forint; IDR = Indonesian rupiah; INR = Indian rupee; LATAM = Latin America; MXN = Mexican peso; MYR = Malaysian ringgit; PEN = Peruvian sol; PHP = Philippine peso; PLN = Polish zloty; Q1 = rst quarter; Q2 = second quarter; RON = Romanian new leu; THB = Thai baht; YTD = year to date; ZAR = South African rand.
United States (Figure 1.14, panel 4). Greater policy alignment should stabilize interest rate differentials between advanced economies and emerging markets. That said, it may also increase the sensitivity of bond yields in emerging markets to those in advanced economies, both because expected policy paths will be more synchronized and as a result of spillovers from the term premium component that captures uncertainty in interest rates. Increases in term premiums in most emerging markets (Figure 1.14, panel 5), likely resulting from larger spillovers from higher US term premiums (Figure 1.14, panel 6), have primarily driven recent changes in yields.
Portfolio Outflows Risks Have Receded Somewhat
Portfolio flows to emerging markets have been positive on net in recent months (Figure 1.15, panel 1). Several countries, notably Egypt and Türkiye, have experienced large inflows into local currency bonds amid renewed investor optimism about the outlook despite lingering debt challenges and elevated inflation, and flows into Indian markets have benefited from India’s inclusion in global bond indices. Conversely, equity flows have been under pressure in some countries, which may reflect concerns regarding the growth outlook or political uncertainty in some cases. Year-to-date international issuance of sovereign bonds has risen to its highest level since 2021, although weak inflows into hard-currency bond funds suggest that market conditions could become more challenging absent a turnaround.
The IMF’s capital-flows-at-risk measure indicates that there is a 5 percent probability that emerging market outflows could reach 2.4 percent of GDP over the next three quarters, a marginal increase in outflow risk since the April 2024 Global Financial Stability Report. However, rising market volatility, as seen during the early August shock, would materially increase outflows risks if sustained over a longer period (Figure 1.15, panel 2). Changes in the investor base have mitigated the risks of portfolio outflows to some extent, as longterm domestic investors like insurers and pension funds have absorbed increasing shares of emerging market bonds, likely serving as a stabilization force (see Box 1.4). Foreign investors appear to have become more cautious about emerging market assets in aggregate, as portfolio inflow cycles have become shorter and smaller on average (Figure 1.15, panel 3). Global factors—such
as the interest rate environment or geopolitical uncertainty—may continue to affect the relative attractiveness of cross-border investment in emerging markets. Indeed, dedicated emerging market bond and equity funds domiciled in the United States have experienced cumulative outflows since March 2022 (Figure 1.15, panel 4).
Emerging Markets with Weaker Fiscal Buffers Could Face More Constrained Funding Conditions
Although many emerging markets have experienced lower financing costs in recent years, investors continue to be attuned to these markets’ fiscal sustainability. After progress following the pandemic, the momentum on fiscal consolidation has waned, and market analysts’ consensus expectations regarding the budget balance for the aggregate government in 15 major emerging markets over the next three years have become more pessimistic and are firmly in deficit territory (Figure 1.16, panel 1), with 11 of these countries set to underperform13 analysts’ forecasts for fiscal year 2024.
Some sovereigns could be ensnared in a “debt begets more debt” quandary, especially considering that stillhigh global interest rates, larger financial spillovers from advanced economies, and weaker prospects in regard to longer-term economic growth are making it more difficult to service existing debt. To avoid such an outcome, these sovereigns need to improve their primary balances. And yet many emerging markets are operating well below their long-term fiscal buffers,14
13 Compared to analysts’ consensus estimates made in the third quarter of 2022.
14 The concept of fiscal buffers is motivated by the primary balance space, as described in the April 2024 Fiscal Monitor. The debt-stabilizing primary balance for the contemporaneous year can be defined as:
given the values of the nominal effective interest rate () and growth rate (). In this context, the long-term debt-stabilizing primary balance is simplified as:
with the assumption that the effective steady-state long-term interest rate () is equivalent to the nominal forward five-year yield in five years, implied by the rate on current on-the-run government bonds, adjusted by differences in term premiums. The interest rate is also weighted by outstanding local- and foreign-currency-denominated debt and takes into account the cost arising from annualized depreciation of the external debt based on historical long-term data (January 2000 to July 2024). Long-term nominal growth () is derived from World Economic Outlook estimates, and gross debt () is based on the prevailing gross government debt level as of the end of 2023. The 2024 fiscal buffer is estimated by subtracting the long-term debt-stabilizing primary balance from the expected 2024 primary balance.
INDUSTRIAL POLICY COVERAGE IN IMF SURVEILLANCE
BACKGROUND PAPER III: RELEVANCE OF AML/CFT TO OTHER FUND POLICIES
