Navigating Choppy Waters: The Resilience of Emerging Markets

The global economy underwent considerable volatility in recent years. First there was the pandemic-related downturn, followed by an unexpectedly strong rebound. Supply-chain disruptions, excess savings being drawn from, tight labor markets, and the Russian invasion of Ukraine all contributed to a surge in prices. Countries that had previously worried about deflation suddenly faced significant inflationary pressures. Inevitably, the inflation shock subsequently triggered an interest rate shock, with major central banks - somewhat late to the party - tightening monetary policy at the fastest pace in decades. Eventually, policy rates peaked, but given resilient economic activity and slow disinflation, global financing conditions have remained rather tight for quite some time.

Emerging markets: showing resilience amid global challenges

Despite all these headwinds, activity in Emerging Markets and Developing Economies (EMDEs) proved much more resilient than initially expected. For instance, by the end of 2023, real GDP of EMDEs was 0.9 percentage points higher than the IMF had projected in October 2022. This is substantial for a group of diverse countries with a growth potential of around 4% per annum. Certainly, there is significant regional and cross-country variation, with some countries performing worse than anticipated. But overall, it is resilience that characterizes the majority of EMDEs. What explains this?

Strengthened institutions underpin resilience

Several factors are at play, but a key contributor has been institutional improvements over the past decade. Looking at responsAbility’s very broad investment universe of over 70 EMDE, we see a clear improvement in (Worldwide) Governance Indicators (from the World Bank) covering fields such as government effectiveness, rule of law and – to a lesser extent – control of corruption.

This institutional strengthening has been especially evident in how central banks in EMDEs have responded to surging inflation in recent years, with their monetary policies generally proving more responsive and decisive than those of advanced economies. In addition, improved external balances, higher (reserve) buffers and fewer exchange rate misalignments signal improved policymaking across many EMDEs.

Pandemic leaving scars on public finances

This is not to say that there are no EMDEs that currently struggle. The pandemic left lasting scars, particularly in the form of higher debt levels. Several sovereigns stopped servicing their debt obligations, while others are likely to default over the coming years.

Looking at public debt ratios, particularly gross public debt as a percentage of GDP, EMDE indebtedness seems at its highest since the turn of the millenium (with IMF data not going further back). However, when looking at debt affordability, the picture changes dramatically. Despite rising debt servicing costs over the past 10 years, EMDEs are devoting a smaller share of their public revenues to debt service than in the early 2000s.

Moreover, there has not been a systematic deterioration of EMDE sovereign ratings over the past decade, with the median rating only slightly declining. The overarching story here is one of significant differentiation between markets, rather than a general market trend.

As for private debt, again, it is true that debt levels have surged significantly, at least in aggregate. Domestic credit to the private sector, as a proxy for private indebtedness, has almost doubled in EMDEs since 2010, rising from 73% to 135% of GDP by 2023. In comparison, the ratio in advanced economies has only increased modestly from 140% to 154%.

Private indebtedness mainly skyrocketing in China

However, like many other EMDE aggregate measures, this one is also skewed by China and its heavy weight. Excluding China, where private debt has increased dramatically to 195% of GDP by 2023, the picture looks very different for EMDEs, with private sector credit remaining relatively stable on a rather low level over the past decade with a moderate uptick during the pandemic which has consolidated since.¹

Differentiation, not decline

In conclusion, while headlines often highlight concerning developments in a few countries - such as a sovereign debt restructuring in Ukraine, political turmoil in Bangladesh, foreign exchange scarcities in Bolivia, or a security crisis in Ecuador - these situations represent a relatively small subset of EMDEs. In reality, the vast majority of EMDEs are showing remarkable resilience, successfully navigating the choppy waters of today's complex global environment.

¹For quite a number of EMDE, the data on domestic credit to the private sector is not yet available for 2022 and 2023. As such, these two aggregated data points (domestic credit in EMDE ex. China in 2022 and 2023) might still change.