Altered Course of Outgoing Currents
Published on August 5, 2025
In the ever-changing landscape of global finance, emerging market economies (EMEs) have witnessed a significant shift in portfolio flows. This transformation, evident since the 2007 global financial crisis, has seen a move from equity and forex loans to bonds, a trend driven by several factors.
The increased emphasis on relative risk and creditworthiness in the post-crisis environment, combined with investors' preference for more stable and safer assets, has played a primary role in this shift. Global financial conditions, with loose funding conditions and low U.S. interest rates post-crisis, have also encouraged bond issuance and investor demand.
Risk management, global macroeconomic shifts, and market dynamics have further fuelled this trend. Bonds, with their predictable cash flows and lower volatility, are more attractive in volatile emerging markets, especially during periods of global uncertainty. The increased volumes and favourable issuance conditions for bonds in emerging markets have made them more accessible and liquid, further attracting portfolio flows over other asset classes.
However, this shift towards safer, more credit-rated assets in a post-2007 risk-averse global environment has its challenges. The provision of enhanced risk premia in the interest rates associated with bond financing can make external borrowing expensive and increase the domestic currency burden associated with servicing the debt.
Moreover, the increase in domestic currency borrowing from foreign creditors is not all good news and can also prove to be as volatile as the flow of foreign finance to the EMEs. The riskiness of foreign currency bond issues for borrowers is higher due to foreign exchange risk.
Despite these challenges, the rise in the share of local currency bond issues in total external financing may be promising. However, it accounts for only a quarter of total external portfolio financing. The need to transform domestic resources into foreign currency to service external liabilities is a cause of external debt repayment difficulties. If a local currency depreciates relative to the currency in which debt is denominated, the burden of interest and amortization payments rises in terms of the local currency.
The Bank for International Settlements (BIS) recently released a study showing that foreign portfolio flows to EMEs fell to $176 billion in 2023, far below the flow of $638 billion recorded in 2021. Yet, with the flow of foreign finance to EMEs, the currencies of these countries have been less prone to depreciation in the short term, and in some periods and cases, they have even appreciated.
In recent years, there has been a boom in sovereign bond issues in less developed economies, including EMEs, and private corporations in some EMEs have also been issuing bonds to secure foreign financing at attractive interest rates. The share of local and foreign currency bonds held by non-resident investors in EMEs increased from 33% in 2006 to 51% in 2024. Foreign bond investors are willing to carry the exchange rate risk associated with such borrowing.
In conclusion, the shift in portfolio flows towards bond financing in EMEs is a strategic response to the post-2007 global financial environment, characterised by easier liquidity but heightened caution towards emerging markets. While this shift offers benefits, it also presents challenges that EMEs must navigate carefully to ensure sustainable growth and financial stability.
- The shift in portfolio flows towards bond financing in emerging market economies (EMEs) is a strategic response to the post-2007 global financial environment, driven by factors such as increased risk awareness, global financial conditions, and market dynamics.
- The increased emphasis on relative risk and creditworthiness in the post-crisis environment has led investors to prefer more stable and safer assets, like bonds, over equity and forex loans in EMEs.
- Investors, particularly those in the global finance sector, are attracted to bonds due to their predictable cash flows and lower volatility, making them more attractive in volatile emerging markets.
- However, the shift towards safer, more credit-rated assets in a post-2007 risk-averse global environment has its challenges, including the provision of enhanced risk premia in interest rates and the riskiness of foreign currency bond issues for borrowers.
- Despite these challenges, foreign portfolio flows to EMEs have declined significantly, yet with these flows, EME currencies have been less prone to depreciation in the short term, and in some periods, they have even appreciated.
