The Financial Stability Board (FSB) has on April 26th published a report on the interaction between US dollar funding and external vulnerabilities in emerging market economies (EMEs). The report has been prepared in collaboration with the IMF and forms part of the FSB’s work programme on non-bank financial intermediation. The report proposes policy measures to address EME vulnerabilities arising from foreign currency borrowing. These include measures to tackle the build-up of foreign exchange mismatches; enhance crisis management tools; and address data gaps to facilitate risk monitoring and the timely adoption of policies. The report also stresses the importance of ongoing work to address vulnerabilities from liquidity mismatches in open-ended funds, which would also help bolster the resilience of EMEs’ financial systems.
These policy proposals are informed by an analysis of EME capital flows during March 2020, with a particular focus on the role of non-bank investors. During this episode, EM investment funds experienced substantial redemptions that were larger than the 2013 ‘taper tantrum’. Analysis suggests that jurisdictions which relied more on global and passive bond funds tended to face greater capital outflows.
The report also discusses relevant policy measures taken in March 2020. EME authorities deployed both standard crisis management tools and new measures to mitigate pressures in local currency bond markets and to stem capital outflows. Actions by advanced economy authorities were also important in mitigating strains in financial markets globally and addressing USD funding pressures. However, these actions did not directly address underlying vulnerabilities in EMEs.
Lael Brainard (Governor of the US Federal Reserve Board), as Chair of the FSB Standing Committee on the Assessment of Vulnerabilities that oversaw the preparation of the report, said “This report provides us with a clearer understanding of the EME vulnerabilities stemming from external funding and non-bank financing. It provides a good basis for further policy work both by authorities in those countries and at the international level to improve the resilience of EMEs’ financial systems to future shocks.”