Rethinking emerging market debt: A changing risk landscape

Recent turbulence emanating from the US has demonstrated a change in attitudes. Despite evident volatility, the dollar weakened, contrary to what would typically be expected in times of stress. The perception of risk between emerging markets and developed markets are no longer black and white. So, are investors now rethinking emerging markets?

In reality, emerging markets (EMs) face a legacy of misconceptions. When the EMs universe was first launched, many risks were idiosyncratic, individual country risks, while investors were sanguine about those facing developed markets (DMs). Today, we are experiencing a convergence in perceptions of risk, as DMs grapple with challenges from fiscal, growth and productivity perspectives.

DM economies are beginning to be characterised by large fiscal deficits and growing political instability. Meanwhile, EMs profit from low debt-to-GDP ratios, as well as an improved reputation for fiscal discipline. This can be seen in the positive rating migration in 2024, with 14 EM sovereigns receiving upgrades – the most positive year for net upgrades since 2011¹.

At a time when investors are growing increasingly concerned about the sustainability of US debt, EM countries benefit from relatively low levels. The average debt-to-GDP ratio of emerging market and middle income economies is 75%, while that of advanced economies is 110%². Stable debt levels create a buffer to absorb global shocks.

EM economies have been outgrowing developed economies fairly consistently over the last few decades – and this looks set to continue. According to the International Monetary Fund (IMF), emerging and developing economies grew 3.7% in the year to April 2025, while advanced economies grew 1.4%.

Even in light of the tariff announcement, the IMF’s April prediction for US growth in 2025 is 1.8%, a -0.9% downgrade since its January prediction. Meanwhile, EM growth was downgraded to a lesser extent, by -0.5%³.

Emerging markets profit from low debt-to-GDP ratios, as well as an improved reputation for fiscal discipline.

Growth levels could also experience a boost in the post-tariff paradigm, where manufacturers move to near-shoring or friend-shoring, or buoyed instead by domestic markets or intra-regional trade. Furthermore, the breadth of the accessible EM universe, encompassing nearly 100 countries, ensures that despite country-specific growth risks as a result of tariffs, there is plenty of room for diversification.

The EM growth story also benefits from a more positive demographic impulse. 85% of the world population lives in an EM country⁴, with many EM economies benefitting from ongoing population growth. This creates growth momentum, with a larger working age population, as well as stronger potential for domestic consumption. Meanwhile, DM economies are grappling with the additional strain of a declining workforce and an increased burden of an ageing population on government debt.

Source: United Nations, Department of Economic and Social Affairs, Population Division (2024). World Population Prospects: The 2024 Revision.

The inflation story in EMs has been largely more straightforward than in DMs. Central banks in EMs acted effectively in the wake of the COVID-induced inflationary bout to mitigate the impact of runaway inflation. For example, Brazil’s central bank hiked rate 12 months before the first move by the US Federal Reserve (Fed). By moving so decisively, not only was inflation tamed in most EM countries, but many countries have also benefited from positive real rates, offering attractive opportunities for investors.

Far from the material impact created by the swift and decisive action, this episode also allowed EM central banks to demonstrate their credibility which has buoyed investor faith in their debt markets.

EM economies have been outgrowing developed economies fairly consistently over the last few decades – and this looks set to continue.

In recent years dollar strength has been a headwind for emerging market debt, but 2025 has seen the end of the dollar’s hegemony.

The dollar has now had the worst start to the year since 1973. This is beneficial to local currency bonds in emerging markets – bonds issued in a country’s respective currency, which have outperformed most parts of fixed-income throughout the first half of the year.

Given the debt dynamics facing the US, the move away from the dollar as the world’s reserve currency could be the beginning of a longer-term trend.

The credit quality of the corporate universe has also been steadily improving.

The number of EMs issuers rated CCC+ and lower declined to nine at the end of April 2025. This compares to 15 in January⁵. EM companies can be characterised by more favourable debt metrics with lower net leverage levels and stronger interest coverage ratios.

Source: JP Morgan, Bloomberg Finance L.P, CapitallQ. June 2025.

Furthermore, EMs have continued to display a lower default rate compared to developed markets, with the 12-month trailing speculative-grade default rate coming in at 0.9% for EMs, versus 4.3% in the US and 3.8% in Europe⁶.

As investors look to reduce their exposure to US assets, emerging markets debt is proving to be a relatively safe harbour.

¹ Fitch Ratings, ‘Emerging market sovereigns benefit from net positive rating actions’, (fitchratings.com), 18 October 2024.
² International Monetary Fund, ‘Gross debt position’, (imf.org), April 2025.
³ International Monetary Fund, ‘A Critical Juncture Amid Policy Shifts’, (imf.org), April 2025.
⁴ Financial Times, ‘Emerging markets has become a redundant term’, (ft.com), September 2024.
⁵ S&P Global, ‘Emerging Markets Monthly Highlights’, (spglobal.com), June 2025.
⁶ S&P Global, ‘Emerging Market Risky Credits Number Drops Amid Market Slowdown’, (spglobal.com), May 2025.