By COMFORT OGBONNA
War, trade tariffs and sharp swings in technology stocks have done little to slow the flow of investment into emerging markets, as years of economic reforms, stronger domestic financial systems and efforts to diversify away from U.S. assets reshape the investment landscape.
Global shocks that previously would have triggered heavy sell-offs across developing economies have so far failed to derail investor demand. Emerging-market debt inflows have reached their highest level in more than two decades, while governments have taken advantage of strong demand to issue record amounts of bonds.
The resilience reflects significant changes in the economic foundations of many developing countries. Improved policymaking, larger foreign-exchange reserves, stronger central banks and growing pools of domestic investors have provided a buffer against external shocks that once left emerging economies highly vulnerable to sudden capital flight.
“Roughly from 2015 to 2025 was like the valley of tears for emerging markets: strong dollar, U.S. exceptionalism, lots of crises, defaults, COVID, etc.,” said David Hauner, head of emerging-markets fixed-income strategy at Bank of America.
The difficult period, however, forced many countries to strengthen their financial systems and reduce their dependence on foreign capital.
“There was so much outflow, a few months of inflows are not going to compensate for that… it’s still only scratching the surface of the under-investment that has occurred over the past decade,” Hauner said.
The resilience is being tested by a series of global pressures. The war that began in February has largely restricted traffic through the strategically important Strait of Hormuz, contributing to higher global oil and fertilizer prices and raising concerns about food costs and broader inflation.
At the same time, investors remain concerned that the U.S. Federal Reserve could raise interest rates, which would strengthen the dollar and potentially put pressure on emerging-market currencies. U.S. Treasury yields, which play an important role in determining borrowing costs for developing countries, remain close to multi-year highs.
Yet those risks have not been enough to reverse the broader flow of capital into emerging markets.
“We can see the fundamentals weakening in the developed world,” said Jetro Siekkinen, head of emerging-market fixed income at LGT Capital Partners, pointing to rising debt-to-GDP ratios in advanced economies.
Many emerging economies, by contrast, have spent years strengthening their institutions, improving central-bank independence and accumulating foreign-currency reserves. Countries including Pakistan, Ghana, Ecuador, Nigeria and Argentina have also received credit-rating upgrades, helping improve investor perceptions of their economic prospects.
“The diversification away from U.S. Treasuries I think is driving this latest performance of emerging markets and frontier as well,” Siekkinen said.
Foreign capital flows highlight the strength of the trend. Foreign investors put about $214.4 billion into emerging-market debt through July, up from $177.7 billion during the same period a year earlier.
Emerging-market governments also took advantage of investor appetite by selling roughly $19 billion of bonds in July, about twice the average amount issued during the month over the previous decade. Total bond issuance for the year reached a record $187 billion.
The strong performance has come despite growing caution in some parts of the investment community. Some major global investors have reduced their enthusiasm for emerging-market equities and hard-currency debt, reflecting concerns over valuations, geopolitical risks and the uneven economic outlook across developing countries.
Artificial intelligence-related investment booms and sudden corrections have also increased volatility in emerging-market equities. South Korea and Taiwan, which have large technology sectors, account for a significant share of the region’s technology-heavy stock market exposure.
That has contributed to substantial equity outflows. Investors pulled about $86 billion from emerging-market equities through July, nearly 10 times the amount withdrawn during the same period last year.
The contrast between debt and equity flows highlights an important shift in investor behavior. While emerging-market stocks have been vulnerable to technology-sector volatility and changing expectations for global growth, local-currency bonds have benefited from improving domestic fundamentals and attractive yields.
Investors are nevertheless becoming increasingly selective. Developing economies remain exposed to food inflation, higher fertilizer costs and potential disruptions caused by climate patterns such as El Niño. Countries that depend heavily on imported food and energy could face particularly strong inflationary pressures if commodity prices remain elevated.
Siekkinen said investors are not simply following broad emerging-market benchmarks but are instead choosing individual countries based on their economic fundamentals, debt levels, currency prospects and available yields.
LOCAL MARKETS PROVIDE A BUFFER
Emerging markets learned painful lessons during the COVID-19 pandemic, when sudden investor withdrawals contributed to severe financing problems and debt defaults in several countries.
The experience accelerated efforts to develop deeper domestic bond markets and reduce dependence on foreign investors, whose capital can quickly leave when global financial conditions deteriorate.
Larger emerging economies such as South Africa and Brazil now finance much of their government borrowing through domestic debt markets. The scale of those local markets has grown dramatically.
Local-currency sovereign bonds outstanding totaled roughly $13 trillion by the end of 2024, compared with about $1.4 trillion in international hard-currency sovereign debt, according to industry research.
The development of these domestic markets means governments can rely more heavily on local investors and are less exposed to sudden changes in international investor sentiment.
Hauner said currencies in countries including Brazil, Colombia, Egypt and Nigeria are particularly well positioned as investors search for opportunities outside traditional developed-market assets.
Domestic investors are also playing a larger role in stabilizing financial markets during periods of global uncertainty.
“The whole pattern of how shocks spread into EM financial markets is different nowadays,” said Magdalena Polan, head of emerging-market macro research at PGIM.
“Large local investors play some stabilizing role, and that means that the markets do not sell off rapidly, and that there are very few liquidity crunches in most countries,” she said.
The increased participation of domestic pension funds, banks, insurance companies and other institutional investors has helped reduce the impact of sudden foreign withdrawals.
This does not mean emerging markets are immune to global shocks. Higher oil and fertilizer prices could increase inflation, while a stronger dollar could raise the cost of servicing foreign-currency debt. A prolonged disruption to energy supplies could also put pressure on trade balances and government finances in countries that rely heavily on imports.
Inflation risks linked to El Niño and higher fertilizer prices are among the biggest threats to the continuation of strong investment flows, Polan and Hauner said.
Still, many investors believe the structural improvements made by emerging economies over the past decade could support further gains.
“We expect outperformance of EM local debt to extend between now and year end,” said Lamine Bougueroua, a fund manager at Carmignac.
“Investors are realizing they may be over allocated to U.S. assets, and they’re allocating to EM. And with geopolitical uncertainty, you want to be diversified in as many jurisdictions as possible.”
The shift represents a significant change from the period when emerging markets were heavily dependent on foreign capital and vulnerable to every major move in the dollar or U.S. interest rates.
For investors, the appeal is increasingly tied not only to higher yields but also to diversification. As economic policies improve and local financial markets deepen, emerging economies are becoming better equipped to absorb global shocks.
The challenge will be maintaining that resilience as geopolitical tensions, commodity-price volatility, inflation risks and uncertainty over global monetary policy continue to shape financial markets.
For now, however, the steady flow of capital into emerging-market debt suggests investors are increasingly willing to look beyond traditional U.S. assets in search of higher returns, greater diversification and economies that have strengthened their defenses against the next global shock.
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