Emerging market economy exchange rates and local currency bond markets amid the Covid-19 pandemic

Key takeaways

• Borrowing through domestic currency bonds has not insulated emerging market economies (EMEs) from the financial shock unleashed by Covid-19; EME local currency bond spreads spiked amid sharp currency depreciations and capital outflows.
• Portfolio investors face amplified losses as local currency spreads and exchange rates move in lockstep; their revised portfolio allocations in turn strengthen this correlation.
• EMEs with monetary policy frameworks that are equipped to address the feedback loop between exchange rate depreciation and capital outflows stand a better chance of weathering the financial fallout from the Covid-19 pandemic.
• To counter large stock adjustments in domestic bond markets, EME central banks may need to expand their toolkit to take on a "dealer of last resort" role; a number of them are already moving in this direction.

The views expressed in this publication are those of the authors and do not necessarily reflect the views of the BIS or its member central banks.