Rethinking risk in EMD

Read this article to understand:

• The fiscal positions of developed versus emerging economies
• The current difference in yields between developed market (DM) and EM bonds
• Three forces that could accelerate a repricing of EM debt

For much of modern market history, investors have treated emerging market bonds as the high-yielding, high-risk corner of global fixed income. The logic was simple: emerging economies carried volatile politics, fragile institutions and currencies prone to sharp devaluations. Developed markets, by contrast, offered a stable political and policy backdrop. 

But the macro and market conditions that once defined “risk” have inverted, challenging one of the most durable pricing conventions in global fixed income: the idea that emerging markets should trade at a discount. 

Macroeconomic and market shifts

The fiscal position of many advanced economies has deteriorated sharply since the COVID-19 pandemic. The US, which provides the benchmark for global “risk-free” assets in the form of Treasuries, now runs a fiscal deficit of more than 6 per cent of GDP and a debt-to-GDP ratio near 120 per cent; both levels typically associated with emerging sovereigns under pressure. Japan’s ratio exceeds 230 per cent, while in Europe, ageing populations and persistent spending commitments are raising debt burdens.

Moreover, geopolitical risk is increasingly centred on developed economies. Credit rating agencies are taking note: the Moody’s downgrade of the US in May and Scope Ratings’ cut in October that cited governance and fiscal deterioration highlight how the boundary between “safe” and “risky” debt is blurring. Contrast that with the evolution of many emerging markets. The fiscal and monetary response to recent global shocks has been far more orthodox than in previous cycles. Central banks in Brazil, Mexico and Chile, for example, raised interest rates around the pandemic well before big economies moved. 

Debt metrics are also more benign. According to International Monetary Fund data, the median EM public-debt-to-GDP ratio is about 70 per cent, compared with 112 per cent in advanced economies. Several frontier and middle-income sovereigns, notably Indonesia, India and the Gulf states, have implemented medium-term fiscal frameworks aimed at preserving debt sustainability while supporting infrastructure and social spending. Institutional progress has also been meaningful. The adoption of inflation-targeting regimes, deeper local-currency bond markets and improved external buffers have now become entrenched norms, reducing the historical vulnerability to capital-flight crises.

EM yields remain elevated

Yet despite these shifts, EM sovereign debt continues to trade at a substantially higher yield to developed market equivalents. The JPMorgan GBI-EM index of bonds in local currencies currently yields about 5.92 per cent, versus 3.45 per cent for the Bloomberg Global Aggregate.

That premium is increasingly difficult to justify. Credit quality dispersion within the EM universe has widened, but a growing share of EM debt now sits comfortably within investment grade. 

If investors were to price risk on fundamentals rather than convention, parts of the EM complex would arguably deserve a valuation premium. Consider Mexico, which has a debt ratio at 49 per cent per of GDP, less than half that of the US. Or ten-year local bond yields of Indonesia, which yield roughly six per cent despite consistent current-account discipline and a young, expanding workforce. 

Three themes to watch

Three forces could accelerate this re-pricing:

1. The global savings glut is now in structural decline. As ageing populations in advanced economies begin to draw down assets, capital will increasingly flow towards regions with higher productivity and demographic growth. EMs fit that description.
2. The rise of local investors, namely pension funds, insurers and sovereign wealth funds, is anchoring demand for domestic debt, reducing reliance on volatile foreign inflows. In India, for instance, local institutions now hold more than 90 per cent of government securities, making the market more resilient to global shocks. 
3. Index inclusion is deepening global investor access. The recent Bloomberg and J.P. Morgan inclusion of Indian and Saudi Arabian government bonds in key indices, with other “watchlist” candidates likely to follow, is channelling $30-50 billion of passive inflows into the asset class. Indeed, more broadly, EM debt still commands a tiny portion of most strategic asset allocations. This can only grow. 

Conclusion

The world has changed faster than its pricing conventions. Bond investors who continue to define “risk-free” as “developed” and “risky” as “emerging” may soon find those assumptions challenged by data, demographics and debt dynamics. 

This article first appeared as an exclusive op-ed in the Financial Times on November 11, 2025.