Head of Emerging Market Sovereign Research
In October, several members of our Emerging Market Debt team travelled to Bangkok for the IMF and World Bank Annual Meetings. We met finance ministers, central bank governors, IMF mission staff and local experts covering more than 50 of the emerging market countries in which we invest. With thousands of attendees from the private and public sectors, the meetings also gave us a useful sense of the market consensus and the policy themes shaping individual countries.
Tariff, oil and interest rate shocks have exposed vulnerabilities across global markets, yet many emerging economies have entered this period with stronger external balances, more flexible policy frameworks and better fiscal starting points than in past cycles.
Stronger fundamentals support resilience
Many emerging market countries have moved away from fixed exchange rates, built reserve buffers and reduced their reliance on external borrowing. These stronger fundamentals are reflected in an improvement in average emerging market credit quality.
Recent experience is also encouraging. Emerging markets have absorbed a series of shocks with better outcomes than many expected. Tariffs rose, yet emerging markets still recorded their largest current account surpluses on record. The oil shock followed, but alternative transport routes and demand substitution, including China’s shift towards renewables, provided more flexibility than anticipated.
Three key takeaways from our discussions
- Resilience is structural: flexible exchange rates, stronger reserve buffers and less reliance on external borrowing have improved emerging markets’ ability to absorb shocks.
- The relative fiscal picture matters: compared with many developed markets, emerging economies generally combine lower fiscal deficits and debt levels with higher growth.
- Opportunity is selective: attractive duration, supportive credit technicals, diversification benefits and country differentiation shape the investment case.
More recently, higher interest rates have brought fiscal concerns in developed markets, including Europe, into sharper focus. In contrast, many emerging markets stand out for their lower fiscal deficits, lower debt levels and stronger growth. Exhibit 2 illustrates the improvement in fiscal balances in emerging market and developing economies, compared with a deterioration in advanced economies. However, enthusiasm in capital markets can fade quickly, particularly as equity investors begin to test the profitability case for artificial intelligence (AI) more seriously. Travelling in Asia also brought home the competitiveness of lower-cost models. China’s focus on making products cheaper and better has already transformed the car industry outside the US. The prospect of prolonged conflicts in Iran and Ukraine remains a source of investor caution.
Implications of greater resilience
These observations have four implications for the assessment of emerging market debt:
- The backdrop for duration is becoming more supportive after a difficult year for fixed income investors, particularly if equity or AI-related volatility increases. Inflation concerns in emerging markets are generally well contained, while emerging market local yields continue to offer an attractive risk premium.
- Credit selection requires particular care while interest rates remain high. Even so, technical conditions look relatively favourable, with little or no net external issuance from emerging markets, especially among corporate borrowers. Furthermore the asset class remains structurally under-owned.
- Greater equity market concentration and circular financing associated with the AI trade reinforce the case for diversification. Emerging market debt can provide exposure to a broader range of return drivers, including country-specific reform, commodity and policy dynamics.
- Country selection remains crucial. We see scope for reform or support from elevated commodity prices in countries including South Africa, Nigeria, Hungary and Colombia. Governance concerns and pressure on fiscal sustainability also need to be assessed at the country level.
Our discussions in Bangkok reinforced the view that emerging market debt’s resilience rests on strengthened fundamentals, including improved fiscal balances, stronger reserve buffers and more flexible exchange rates. These stronger fundamentals help explain how emerging markets have absorbed recent shocks, although differences between countries remain crucial to assessing the asset class.