How emerging market debt is adapting to a sea of change

Furthermore,  the US dollar has had its weakest start to a year in decades, and history tells us that EM assets tend to benefit in such environments. While the dollar’s decline isn’t the only driver, it has certainly helped local currency bonds outperform. The broader question now is whether we’re seeing the early stages of a cyclical decline in the dollar. Rising US deficits, slowing growth, and shifting policy dynamics suggest the narrative of US exceptionalism may be losing steam, potentially prompting a rotation into EM assets, which by contrast are underpinned by lower deficits and stronger debt sustainability. 

Building a credible framework

Underpinning this evolution is a transformation in EM credibility, both in terms of monetary and fiscal policy.

While historically EMs have been vulnerable to external shocks, such as the Global Financial Crisis, EM governments and central banks have since built credible frameworks that provide a degree of protection from such events.

We have seen this demonstrated throughout the most recent economic cycle where EMs are no longer just reactive to US monetary policy but have moved independently. 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 relatively quick order across EM countries, but many countries have also benefited from positive real rates, offering attractive opportunities for investors.

The evolution of EM policy credibility is one of the most underappreciated shifts in global fixed income.

From a fiscal perspective, 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.

While the threshold for market tolerance of debt levels in EMs is lower, a key measure of affordability of debt is interest payments as a percentage of revenue. In this respect, there is a convergence of behaviours between EM and DM, where certain EM countries, such as Chile and Poland, have interest-to-revenue ratios similar, or below, those of DM³.

Furthermore, the International Monetary Fund (IMF) projects that governments in EM economies will tighten fiscal policy in 2026, in contrast to developed economies where the fiscal balance is projected to worsen.

This is further supported by other recent trends within EM’s whereby we have seen a broad improvement in foreign currency reserves, with the significant increase in local debt markets allowing for even greater stability and autonomy.

We believe these factors make an allocation to EMD increasingly attractive, underpinned by improving fundamentals and a growing independence from US policy cycles, thanks in large to the development of credible, autonomous monetary and fiscal frameworks.

Growth engine

At a time when DM economies are still occupied by growth concerns and lingering inflation, the outlook for EM offers a reprieve.

The first half of 2025 brought stronger-than-expected growth in EMs, with a combination of factors, including improvements in monetary, macroprudential and fiscal frameworks, contributing⁴. EM economies have been outgrowing developed economies fairly consistently over the last few decades – and this looks set to continue. Emerging market and developing economies are projected to grow 4.2% in 2025, while growth of advanced economies is expected to be 1.6%, according to the IMF.

The EM growth story also benefits from a more positive demographic impulse. 85% of the world population lives in an EM country⁵, with many EM economies benefitting from ongoing population growth and more attractive demographics. 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.

Corporate credibility

Not only is the sovereign picture positive for EMs, the credit quality of the corporate universe has also been steadily improving.

EM companies can be characterised by more favourable debt metrics with lower net leverage levels and stronger interest coverage ratios which spreads across both investment grade and high yield issuers.

EMD continues to offer a compelling yield advantage relative to DM credit, particularly high yield. What’s notable is that this comes with stronger credit quality; Around half of the EMD universe is investment grade, and that proportion is rising thanks to a wave of sovereign and corporate upgrades. Many EM issuers are in better fiscal shape than their high yield counterparts, yet spreads remain wider, creating a valuation disconnect that’s beginning to attract attention.

This EM premium is likely to remain, despite the strong underlying fundamentals, as it’s a less well understood market, diversified across many sectors and countries. This can provide a strong opportunity for investors with EM capabilities to take advantage of such dislocations.

The diversification advantage

EMD offers investors access to a wide array of economies, policy frameworks, and growth trajectories. The recent tariff disruptions—particularly those introduced by the Trump administration—have underscored the value of diversification within EMD. Countries like Brazil and Vietnam illustrate how varying economic structures can lead to different levels of exposure and resilience.

Despite initial market volatility following Liberation Day, spreads have since tightened, suggesting that investors are increasingly focused on fundamentals rather than headlines. The broader EM universe, with nearly 100 investable countries, provides ample opportunity to mitigate country-specific risks and benefit from structural shifts such as near-shoring and intra-regional trade.

Moreover, the tariff episode has cast doubt on the durability of US exceptionalism, potentially accelerating a rotation away from US-centric portfolios. With attractive carry, improving fundamentals, and a more credible policy environment, EMD stands out—especially as DMs face mounting challenges.

In short, EMD is evolving. The combination of attractive carry, improving fundamentals, increasing policy credibility, and a potentially weaker dollar creates a favourable backdrop for the asset class, particularly at a time when DM’s are facing increased pressure. We believe now is a good time to reassess its role in portfolios.

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 World Bank, ‘Interest payments (% of revenue)’, (worldbank.org), November 2025
⁴ International Monetary Fund, ‘World Economic Outlook’ (imf.org), October 2025
⁵ Financial Times, ‘Emerging markets has become a redundant term’, (ft.com), September 2024.