Central bank bond buying has once again been among the most dominant and potent forms of economic defence around the globe, this time against the ravages of corona-virus lockdowns.
But while the usual developed market suspects — the US Federal Reserve, the Bank of Japan, the Bank of England and the European Central Bank — have caught most of the attention for their rapid and colossal monetary policy response, central banks in central and eastern Europe have been skillful too in testing quantitative easing (QE) for the first time, keeping domestic markets open and borrowing costs low.
“QE is something that is new for Central Europe,” says Paul Gamble, head of emerging Europe sovereign ratings at Fitch. “However, we have now seen it in four countries.
“We have seen it in Poland, which has been the biggest user of QE as well as in Romania and Croatia, where it’s also completely new. Finally, we have QE in Hungary which has a track record of doing QE but in the past month restarted buying government debt.”
The move to initiate asset purchase programmes came during the height of the sell-offs that ravaged markets in March as societal lockdowns drove down liquidity in local debt markets. That forced central banks to act, as investors pulled their cash.
“At the beginning of this crisis, in late March and early April, there were large redemptions from investment funds and some of them were struggling to get cash,” says Dan Bucsa, chief CEE economist at UniCredit.
Central banks swept in as buyers of government bonds, which kept local currency bond markets open and functioning. These markets provide crucial funding to sovereigns, and keeping them open has helped countries to ride out the crisis so far.
“The local currency bond market is a key facility for sovereigns to finance their budget deficits,” says Trieu Pham, an emerging market debt strategist at ING. “Having the local currency bond markets functioning is important for local market players, but also for the sovereign as an issue in general.”
Local heroes
The efforts to keep domestic markets liquid has had a noticeable effect on sovereign bond yields.
At the beginning of June, Poland’s five year bonds were trading at 0.76%, 105bp lower than on March 16, around the middle of the coronavirus sell-off. Hungary’s five year debt has tightened by 81bp since that date and Czech five year government bonds by 1.25bp.
The squashing of sovereign yield for countries that initiated bond buying programmes is a sign of the policy’s immediate triumph, according to some.
“I think these asset purchase programmes have been extremely successful, especially if you look at the yields across some of these countries,” says Jan Dehm, head of research at Ashmore, a specialist emerging markets investment firm. “The valuations themselves tell you unambiguously that there is no funding stress at all and that these governments are able to borrow at incredibly low rates.
“All the fears that have been expressed that emerging markets are going to have a tough time funding during the coronavirus crisis have simply not been borne out as far as these countries are concerned, because they are looking at nearly record low yields.”
Dehm adds that the reason CEE countries have been so effective in financing themselves through the Covid-19 crisis is that they have come to rely extensively on their domestic bond markets for funding.
That means that these countries are effectively self-reliant for cash. So when the crisis hit, causing foreign investors to pull out, they did not suffer a huge rise in borrowing costs, as is often the case in other emerging markets.
Therefore, the primary concern is not appealing to international investor sentiment, but has become keeping domestic local currency bond markets open.
“Unlike in the old days where there were no domestic bond markets, the loss of international financing is not really having a material impact,” says Dehm. “In fact, what these countries in eastern Europe are showing us now is that they are able to run counter-cyclical fiscal and monetary policy in a crisis, by cutting rates and increasing fiscal stimulus.
“If you think about it, that means that they are behaving exactly like developed markets. This is what used to be the big distinguishing characteristic between developed and emerging markets. It used to be that [only] developed economies could run counter-cyclical fiscal and monetary policy.”
Independence question
But like most things liquid, now QE is out of the bottle, it will be harder to put it back in. One of the main concerns for emerging markets bond players is how quickly the programmes will be unwound once the crisis is over.
This is tied to worries over central bank independence in some countries in the region and their debt levels.
Romania’s levels of debt, for example, were already high before the pandemic, although that is less of a concern politically than it is in both Hungary and Poland, which are both ruled by increasingly populist governments.
Should politicians in those countries exert pressure on the central banks to finance government spending after the Covid-19 crisis has ended, it would call central bank asset purchase programmes into question.
“There’s a chance we will start to see concerns about the credibility of the central banks and whether these measures go on to be considered as fiscal funding or not,” says Pham at ING. “That could then pose a threat to the currency as well.
“There could be a credibility question, if QE is done in an uncontrolled manner.”
In an article written in April on CEE QE, Fitch outlined various risks that it could see as a result of the Covid-19 measures.
It noted that countries with weaker fiscal positions — Romania, for example — might find it difficult to implement policies to reduce debt to pre-crisis levels.
With interest rates lower and many central banks indirectly financing government borrowing though asset purchase programmes, as in Hungary and Poland, central bank independence will be key.
“Institutional independence is definitely something that we are we looking at,” says Gamble. “Obviously, central banks have their mandates and near-term policy goals and we have to see if they remain able to adhere to these.
“The political angle is a more difficult one to think about, because you have to consider the counter-factual, and also that even though there may be a lot of political noise, the central bank actions may not be inconsistent with their mandates.”
By any means necessary
UniCredit’s Bucsa explains that each central bank in the region adopted a different strategy for how best to support their local market and in some cases have adapted their buying plans as the crisis has worn on.
“There are two central banks that are not price sensitive, in Poland and Croatia, and they went in knowing that they would have to provide very swift and large support,” he says. “Poland bought 2.3% [worth of the country’s] GDP in Polish government bonds but it also bought another 1.7% of GDP in bonds issued by the development bank, BGK, and the sovereign investment fund, PFR.
“If you look at the past two auctions, in May, the National Bank of Poland bought mostly the BGK and the PFR bonds rather than government bonds, because funds by now do not face the same liquidity needs.”
Bucsa adds that Croatia has done something similar, buying government bonds equivalent to 3.8% of GDP already. He believes that the Croatian National Bank could spend the equivalent of up to 6.6% of the country’s GDP on government bonds.
CEE central banks are either buying bonds through tenders or through bilateral purchases in the secondary market. Both the National Bank of Poland and the Croatian National Bank are holding tenders to buy bonds.
In Hungary and Romania the situation is different because the two central banks are more sensitive to the price they pay. This means that the size of the purchases was smaller as they did not buy all the bonds on offer. However, both central banks were still active in their sovereign debt markets.
“In Romania, we know that bond purchases were about 0.3% of GDP, until mid-May,” Bucsa says. “In Hungary it was also around 0.3% of GDP.
The Hungarian National Bank holds weekly tenders and purchases bonds in the secondary market, while the National Bank of Romania buys in secondaries only. s