Central banks in emerging markets (EM) face tough monetary policy decisions in coming years as advanced economies eventually start to raise short-term rates and trim their holdings of bonds, with a massive expansion in international debt issuance by EM corporations in recent years raising their vulnerability to foreign exchange swings.
One of the characteristics of global finance in the last decade has been the deeper integration of emerging markets into global debt markets, making them much more sensitive to changes in bond markets in advanced economies, writes Philip Turner of the Bank for International Settlements (BIS) in a highly topical working paper.
Since the financial crises, borrowers from emerging markets have relied more on international bond markets and less on international banks, with EM borrowers raising about $900 billion from international bond investors, double the amount that banks have lent to them.
Some of these corporations are wholly or partly owned by EM governments and despite the turbulence in global bond markets from May 2013, net bond issuance remained quite strong in the second half of last year,” Turner writes in BIS working paper: “The global long-term interest rate, financial risks and policy choices in EMEs.”
Turner examines what the proceeds from these foreign currency bonds could have been used for and concludes that on the face of it, the currency exposures of EM corporates have increased.
He also finds that the issuance of bonds on that scale could affect domestic banking systems in EM countries if the funding were to dry up: This could happen hrough local banks, who might turn their back on small firms if large firms return from global markets, by a drying up of wholesale funding markets, or through the hedging of foreign exchange or maturity exposures by the large corporates.
“As a result of these linkages, the central bank may face greater instability in its domestic interbank market whenever large corporations find it hard to finance themselves abroad,” Turner writes.
The movements in U.S. long-term interest rates can thus have major implications for both monetary policy and financial stability in emerging market economies with the long period of declining global interest rates over.
“Downward pressures on some EM currencies could be accentuated, increasing the local currency cost of servicing dollar debt,” Turner writes, adding:
“Higher long-term rates, currency depreciation and more volatile markets could make even more difficult the choices that EM central banks face on their policy rate, on the exchange rate, on the long-term interest rate and the best use of their balance sheet.”