## ch2

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---

### Key findings
- Cross-border portfolio flows to emerging markets have risen sharply since the global financial crisis, driven largely by nonbank financial investors, with cumulative inflows approaching $4 trillion in 2025.
- Cross-border portfolio flows support market development and expand financing options but carry risks, including heightened sensitivity to shifts in global risk sentiment.
- Sensitivity to global risk varies across investor types:
  - Hedge funds and investment funds react more strongly to shifts in global risk than other nonbanks.
  - Within the investment fund sector, passive mutual funds and exchange-traded funds show the greatest sensitivity.
- During periods of global market stress, emerging markets more exposed to risk-sensitive investors face tighter financial conditions, including reduced debt issuance and wider spreads, with adverse implications for macrofinancial stability.
- Nonbank financial investors pull back less from countries with stronger institutions, ample reserve buffers, or lower fiscal risks when global risk increases.
- Cross-border private credit and stablecoin flows into emerging markets are expanding rapidly:
  - Stablecoin flows remain closely tied to crypto market dynamics and are often elevated in countries with weak fundamentals and policy frameworks, raising currency substitution concerns.

### Policy implications (summary)
- To reduce volatility in cross-border portfolio flows, countries—especially those reliant on more risk-sensitive investors—should:
  - Strengthen macroeconomic fundamentals and institutional quality.
  - Build robust fiscal and external buffers.
  - Pursue proactive risk management consistent with the IMF’s Integrated Policy Framework.
- International cooperation is essential to close regulatory gaps in nonbank financial intermediation and limit cross-border propagation and amplification of global financial shocks.
- More comprehensive disclosure and enhanced international data sharing on nonbank exposures and vulnerabilities could strengthen market surveillance and improve risk management practices.
- The rapid expansion of private credit markets and stablecoins in emerging markets warrants continued, proportionate monitoring, particularly where interlinkages with regulated financial institutions are material.

### Context and scale of exposure
- Portfolio debt liabilities average about 15 percent of GDP and exceed 20 percent of GDP in one-fifth of emerging markets.
- Portfolio equity liabilities average about 7 percent of GDP and represent an economically meaningful share of stock market capitalization in some emerging markets.
- The NBFI sector’s share in emerging market portfolio debt liabilities has doubled to 80 percent over the past two decades.
- Since the global financial crisis, the NBFI sector has grown much faster than the traditional banking sector, accounting for more than half of global financial assets in 2025.
- Nonresident NBFI holdings and flows in the analysis cover about 7,000 institutional investors and 4,000 mutual funds, primarily domiciled in advanced economies and investing in about 50 emerging markets.

### Transmission channels and investor vulnerabilities
- Key structural vulnerabilities that amplify transmission of global shocks through NBFI:
  - Liquidity mismatch and flighty end investors (notably in open-end mutual funds offering daily liquidity but holding relatively illiquid assets).
  - Leverage (financial and synthetic), especially among hedge funds, which can trigger margin calls and forced asset sales.
  - Benchmark-driven investment and passive strategies that induce synchronized trading and potential abrupt price moves.
  - Interconnectedness with the broader financial system, including crypto-related channels.
- Investor-type characteristics:
  - Investment funds account for the bulk of portfolio debt and equity investment in emerging markets and are exposed to redemption risks.
  - Passive funds’ mechanical adjustments to benchmark changes can generate synchronized trading across funds holding overlapping emerging market securities.
  - Exchange-traded funds (ETFs) often have end investors that are liquidity-motivated and institutions engaged in hedging, amplifying trading pressures.
  - Hedge funds typically use more leverage and exhibit stronger procyclicality, having pulled back sharply during major stress episodes (the 2013 taper tantrum, the COVID-19 shock, and monetary policy tightening after the pandemic, including the US Federal Reserve policy tightening in 2022).
  - Insurers and pension funds, managing long-term liabilities, are relatively less procyclical but remain subject to leverage, mark-to-market accounting, and solvency-related asset sales.

### Emerging trends: private credit and stablecoins
- Private credit:
  - Private credit lending to emerging markets has risen markedly from a low base, with assets under management exceeding $50 billion as of the end of 2024.
  - Industry data suggest that emerging markets account for a single-digit share of the global total (less than 5 percent).
  - Deal activity accelerated from about $14 billion in 2024 to more than $22 billion in 2025.
  - Recent estimates place emerging market private credit assets under management between roughly $50 billion and $100 billion, representing a fivefold increase over the past decade.
  - About half of the total is attributed to India, with the rest mostly split between Latin America and China.
- Stablecoins:
  - Gross cross-border flows in the two largest dollar-pegged stablecoins—Tether (USDT) and USD Coin (USDC)—rose from an estimated $12 billion in the first quarter of 2020 to $316 billion in the first quarter of 2025.
  - A large share of these flows has been directed toward emerging markets; cumulative net inflows have accelerated since late 2023.
  - Stablecoin gross flows have reached double-digit shares of annual GDP for Ukraine, Vietnam, and Belarus.
  - Net flows are considerably smaller at just under 1 percent of annual GDP in the largest recipients, consistent with stablecoins being used to facilitate transactions.
  - Inflows comove with crypto activity, remittance and trade flows, and are larger in countries with weaker institutional and political stability, higher inflation, and greater exchange rate volatility.
  - Stablecoin inflows decrease when global funding costs are higher and increase with global risk aversion (VIX) and Bitcoin price volatility.

### Sensitivity of flows to global risk (VIX) and transmission mechanics
- A one-standard-deviation increase in the VIX—about 7 percentage points, comparable to the increase observed in early 2022—is associated, on average, with:
  - a decline of about 0.3 standard deviations (equivalent to around 1 percent of GDP) in quarterly portfolio debt flows to emerging markets;
  - a drop of about 0.2 standard deviations (0.8 percent of GDP) for banking flows;
  - for portfolio equity flows, a similar shock implies a decline of 0.1 standard deviations—around 0.1 percent of GDP.
- Investment funds’ sensitivity:
  - A one-standard-deviation increase in the VIX is associated with a decline of more than 0.5 standard deviations of debt flows to emerging markets by investment funds—about 0.8 percent of GDP—compared with about 0.3 standard deviations for aggregate portfolio debt flows.
  - For equity flows, a similar VIX shock is linked to a decline of almost 0.2 standard deviations for investment funds—about twice the size of the response for total portfolio equity flows (estimate not statistically significant at conventional levels).
- Nonlinear and size-dependent responses:
  - Flows remain relatively unresponsive when the VIX is below its historical average of about 20 but react strongly at higher VIX levels.
  - Sensitivity is greater when portfolio debt flows are particularly large relative to GDP.

### Heterogeneity across investor types and behavior
- Nonresident versus resident:
  - Following a one-standard-deviation increase in the VIX, nonresident investors reduce their emerging market bond and equity investments by 0.6 percentage points more than resident investors.
  - For advanced economy securities, nonresident nonbank investors do not react differently from resident investors.
- Investor-type responses:
  - Hedge funds are the most sensitive, followed by other investment funds.
  - Nonresident hedge funds and mutual funds reduce their emerging market investments significantly more than resident investors when market volatility rises.
  - Nonresident insurance companies and pension funds show no meaningful adjustment on average.
  - The flightiest quartile reduces emerging market holdings by more than twice the median response; a significant share reacts less than resident holders.
- Within investment funds:
  - Nonresident passive funds and exchange-traded funds display markedly higher sensitivity than active mutual funds.
  - Synthetically hedged funds, on average, do not reduce their emerging market investments as much as funds without identifiable synthetic exposures.
  - Leverage effects are most pronounced among exchange-traded funds, consistent with mechanical rebalancing and reliance on margin financing.

### Effects on issuance, spreads, and issuer behavior
- Flighty investors:
  - Defined as the top quintile of nonresident investors by global risk sensitivity (mainly hedge funds and mutual funds).
  - Flighty investors account on average for about 1 percent of emerging market bond markets, rising to as much as 14 percent in some countries.
- Issuance and spreads during stress episodes:
  - A one-percentage-point increase in the ex ante reliance on flighty investors implies:
    - a 28 percent decline in the volume of sovereign debt issuance during stress episodes;
    - a 45 percent decline in the volume of corporate bond issuance during stress episodes.
  - Sovereign and corporate spreads at issuance rise by about 30 basis points and 120 basis points, respectively, during stress episodes for issuers with higher reliance on flighty investors.
  - These changes are economically sizable relative to average stress-period issuance spreads of 313 and 481 basis points (sovereigns and corporates, respectively).
- Issuer behavior:
  - Sovereigns with greater ex ante reliance on flighty investors appear to increase domestic bond market issuance during stress; firms do not similarly substitute by increasing domestic bond issuance or syndicated loan issuance.
  - Total debt of firms reliant on flighty nonresident investors seems to decline in periods of stress, and exposed firms appear to reduce capital expenditure significantly.
  - Issuers with preexisting vulnerabilities (sovereigns with above-median public-debt-to-GDP ratios; firms with above-sector-specific median total-debt-to-total-equity ratios) experience a stronger and more persistent decline in issuance volumes during stress episodes.

### Macrofinancial implications and growth-at-risk
- Reduced sovereign and corporate debt issuance and higher borrowing costs weaken domestic demand through lower consumption and investment, increasing downside risks to future growth.
- Using the left tail of the growth distribution (the 10th percentile) as a measure of downside risk:
  - In countries with greater ex ante reliance on flighty investors, a one-standard-deviation increase in the VIX lowers one-quarter-ahead (annualized) real GDP growth by an additional 6 percentage points relative to countries with lower reliance on flighty investors.
  - The differential effect remains negative for up to four quarters, on average, tapering off subsequently.

### Policy recommendations and surveillance priorities
- Strengthen supervisory and data frameworks to monitor private credit exposures and other NBFI activities, especially where private credit funds operate through opaque structures with limited oversight.
- Enhance surveillance of NBFI–bank linkages (credit lines, repos, derivatives, prime brokerage) to limit spillbacks to the banking system and reduce the risk of deleveraging-driven pullbacks of nonresident flows to emerging markets.
- Monitor and address vulnerabilities arising from reliance on banks for foreign exchange swaps and hedging—prepare to manage surges in hedging demand that can strain FX liquidity during global risk-off episodes.
- Track and regulate growing NBFI exposures to crypto-related assets and the use of stablecoins in cross-border transactions to mitigate contagion risks as crypto–NBFI linkages deepen.
- Build and maintain country-level buffers and institutional strength to reduce sensitivity of portfolio debt flows to global risk:
  - stronger institutional quality;
  - higher reserve adequacy;
  - prudent public-debt-to-GDP ratios.
- Use systemwide stress tests to gauge resilience to sudden capital flow reversals and expand stress testing in source countries to include major nonbank financial intermediaries.
- Recognize the higher flightiness of passive funds, ETFs, and leveraged vehicles (e.g., hedge funds) when designing macroprudential and liquidity-management tools to limit correlated trading and amplification of global risk shocks.
- Policy actions to mitigate correlated asset sales:
  - Strengthen liquidity management of investment funds.
  - Enhance transparency around leverage and derivative use.
- Deepen domestic local-currency bond markets and broaden the domestic investor base to include long-term institutional investors.

*Source: ch2 - Conclusions and Policy — https://www.imf.org/-/media/files/publications/gfsr/2026/april/english/ch2.pdf*

### Chapter 2 at a Glance

### Chapter 2 at a Glance

### Key findings
- Cross-border portfolio flows to emerging markets have risen sharply since the global financial crisis, driven largely by nonbank financial investors, with cumulative inflows approaching $4 trillion in 2025.
- Cross-border portfolio flows offer opportunities by supporting market development and expanding financing options but carry risks, including heightened sensitivity to shifts in global risk sentiment.
- Sensitivity to global risk varies across investor types:
  - Hedge funds and investment funds react more strongly to shifts in global risk than other nonbanks.
  - Within the investment fund sector, passive mutual funds and exchange-traded funds show the greatest sensitivity.
- During periods of global market stress, emerging markets more exposed to risk-sensitive investors face tighter financial conditions, including reduced debt issuance and wider spreads, with adverse implications for macrofinancial stability.
- Nonbank financial investors pull back less from countries with stronger institutions, ample reserve buffers, or lower fiscal risks when global risk increases.
- Cross-border private credit and stablecoin flows into emerging markets are expanding rapidly:
  - Stablecoin flows remain closely tied to crypto market dynamics and are often elevated in countries with weak fundamentals and policy frameworks, raising currency substitution concerns.

### Policy implications
- To reduce volatility in cross-border portfolio flows, countries—especially those reliant on more risk-sensitive investors—should:
  - Strengthen macroeconomic fundamentals and institutional quality.
  - Build robust fiscal and external buffers.
  - Pursue proactive risk management consistent with the IMF’s Integrated Policy Framework.
- International cooperation is essential to close regulatory gaps in nonbank financial intermediation and limit the cross-border propagation and amplification of global financial shocks.
- More comprehensive disclosure and enhanced international data sharing on nonbank exposures and vulnerabilities could strengthen market surveillance and improve risk management practices.
- The rapid expansion of private credit markets and stablecoins in emerging markets warrants continued, proportionate monitoring, particularly where interlinkages with regulated financial institutions are material.

### Context and scale of exposure
- Portfolio debt liabilities average about 15 percent of GDP and exceed 20 percent of GDP in one-fifth of emerging markets.
- Portfolio equity liabilities average about 7 percent of GDP and represent an economically meaningful share of stock market capitalization in some emerging markets.
- The NBFI sector’s share in emerging market portfolio debt liabilities has doubled to 80 percent over the past two decades.
- Since the global financial crisis, the NBFI sector has grown much faster than the traditional banking sector, accounting for more than half of global financial assets in 2025.
- Nonresident NBFI holdings and flows in the analysis cover about 7,000 institutional investors and 4,000 mutual funds, primarily domiciled in advanced economies and investing in about 50 emerging markets.

### Transmission channels and investor vulnerabilities
- Key structural vulnerabilities that amplify transmission of global shocks through NBFI include:
  - Liquidity mismatch and flighty end investors (notably in open-end mutual funds offering daily liquidity but holding relatively illiquid assets).
  - Leverage (financial and synthetic), especially among hedge funds, which can trigger margin calls and forced asset sales.
  - Benchmark-driven investment and passive strategies that induce synchronized trading and potential abrupt price moves.
  - Interconnectedness with the broader financial system, including crypto-related channels.
- Investor-type characteristics:
  - Investment funds account for the bulk of portfolio debt and equity investment in emerging markets and are exposed to redemption risks.
  - Passive funds’ mechanical adjustments to benchmark changes can generate synchronized trading across funds holding overlapping emerging market securities.
  - Exchange-traded funds (ETFs) often have end investors that are liquidity-motivated and institutions engaged in hedging, amplifying trading pressures.
  - Hedge funds typically use more leverage and exhibit stronger procyclicality, having pulled back sharply during major stress episodes (the 2013 taper tantrum, the COVID-19 shock, and monetary policy tightening after the pandemic, including the US Federal Reserve policy tightening in 2022).
  - Insurers and pension funds, managing long-term liabilities, are relatively less procyclical but remain subject to leverage, mark-to-market accounting, and solvency-related asset sales.

### Emerging trends: private credit and stablecoins
- Private credit lending to emerging markets has risen markedly from a low base, with assets under management exceeding $50 billion as of the end of 2024.
- Stablecoin flows into emerging markets are expanding rapidly but remain closely tied to crypto market dynamics and are often elevated in countries with weak fundamentals and policy frameworks, creating currency substitution concerns.

### Data and methods (scope)
- Country-level data on cross-border portfolio and bank flows are used from 2003 to 2025 at a quarterly frequency.
- Security-level holdings data span 2010 to 2025.
- The analysis combines NBFI flows with security-level holdings across sovereigns and firms to identify investor segments most sensitive to global financial shocks.

*Source: Chapter 2 at a Glance*

### 1. Investment Funds’ Portfolio Debt Allocation to Emerging Markets by

### 1. Investment Funds’ Portfolio Debt Allocation to Emerging Markets by Strategy

### Inclusion in Well-Tracked Indices and Market Effects
- Inclusion in the MSCI Emerging Markets Index is associated with excess stock returns around the announcement date (five-day window before and after inclusion). Events covered after 2000 include Pakistan (June 14, 2016), Saudi Arabia (June 20, 2018), Kuwait (June 25, 2019), Qatar (June 11, 2013), the United Arab Emirates (June 11, 2013), and China A-shares (June 20, 2017).
- Excess returns are defined as the difference between returns of a country’s stock market index (in dollars) and the MSCI World Index (in dollars).

### Investment Fund Allocation Patterns
- Panels show total portfolio investment in emerging markets by nonresident investment funds with passive or active strategies (decomposition of debt and equity holdings across time t−5 to t+5).
- Investment funds’ equity and debt allocations exhibit an interquartile range and average path across event windows (years shown: 2006, 09, 12, 15, 18, 21, 24).

### Key data sources and methodological notes
- Data sources include Emerging Portfolio Fund Research; London Stock Exchange Group; MSCI Emerging Markets Index; and IMF staff calculations.
- Panels 1 and 2 present holdings of emerging market debt and equity securities by nonbank financial investors (passive vs active). Panel 3 presents excess returns over a five-day window around index inclusion announcements (excluding Argentina).

---

### Nonbank Financial Investor (NBFI) Exposures and Channels of Contagion

### Expansion of private credit and supervisory gaps
- Expansion in nonbank financing broadened financing options for emerging market borrowers—including infrastructure finance, asset-based finance, and various forms of mezzanine and leveraged finance—particularly where bank lending has been constrained.
- Private credit funds often operate through opaque structures with limited regulatory oversight, complicating assessment of systemic risks (April 2024 Global Financial Stability Report).
- In many emerging markets, weak supervisory and data frameworks increase uncertainty about potential spillovers to domestic financial systems.

### Interconnectedness with banks, foreign exchange, and crypto
- Banks in advanced economies are increasingly exposed to the NBFI sector through credit lines, repos, derivatives, and prime brokerage services—with exposures particularly concentrated in hedge funds.
- The NBFI sector relies heavily on banks for foreign exchange swaps to hedge exposures; during global risk-off episodes, surging hedging demand can strain FX liquidity and amplify emerging market currency volatility (October 2025 Global Financial Stability Report).
- Linkages between NBFI and crypto markets are deepening:
  - Asset managers have introduced a growing range of crypto-related products, including exchange-traded products and tokenized instruments.
  - Many NBFI entities now hold crypto assets or gain exposure through crypto-sensitive securities.
  - Stablecoins—widely used as settlement assets in crypto markets—are becoming more prevalent in NBFI portfolios and their use in cross-border transactions, including in emerging markets, has been growing.
  - The number of globally listed crypto exchange-traded products and exchange-traded funds rose from 19 in 2020 to 405 by November 2025 (Exchange Trade Funds Global Insights, press release, December 31, 2025).

### Measured holdings and concentration
- Figures show holdings of emerging market securities by nonbank investors (hedge funds, pension funds, sovereign wealth funds, insurance companies) and illustrate that known hedge fund positions can be sizable relative to market value of securities in some countries.
- Panel notes: holdings measured at market values; hedge funds’ ownership share shown over 2010–25 for selected emerging markets.

---

### Sensitivity of Flows to Global Risk (VIX) and Transmission Mechanics

### Global picture since the global financial crisis
- The sensitivity of cross-border bank lending to global risk (proxied by the Chicago Board Options Exchange Volatility Index, VIX) has declined relative to portfolio debt flows since the global financial crisis.
- A one-standard-deviation increase in the VIX—about 7 percentage points, comparable to the increase observed in early 2022—is associated, on average, with:
  - a decline of about 0.3 standard deviations (equivalent to around 1 percent of GDP) in quarterly portfolio debt flows to emerging markets;
  - a drop of about 0.2 standard deviations (0.8 percent of GDP) for banking flows;
  - for portfolio equity flows, a similar shock implies a decline of 0.1 standard deviations—around 0.1 percent of GDP.
- This indicates global liquidity has become more responsive to risk through international debt issuance rather than through cross-border bank lending.

### Greater sensitivity for emerging markets and investment funds
- Portfolio debt flows to emerging markets are more sensitive to a one-standard-deviation increase in the VIX than flows to advanced economies (advanced economies show statistically and economically negligible changes).
- Among nonbank financial investors, investment funds investing in portfolio debt securities react almost twice as strongly as portfolio investors considered collectively:
  - A one-standard-deviation increase in the VIX is associated with a decline of more than 0.5 standard deviations of debt flows to emerging markets by investment funds—an economically meaningful effect of about 0.8 percent of GDP—compared with about 0.3 standard deviations for aggregate portfolio debt flows.
  - For equity flows, a similar VIX shock is linked to a decline of almost 0.2 standard deviations for investment funds—about twice the size of the response for total portfolio equity flows—although this estimate is not statistically significant at conventional levels.

### Nonlinear and size-dependent responses
- Portfolio debt flows to emerging markets become increasingly sensitive to the VIX as it rises:
  - Flows remain relatively unresponsive when the VIX is below its historical average of about 20 but react strongly at higher VIX levels.
- Sensitivity is greater when portfolio debt flows are particularly large relative to GDP, which may reflect vulnerability buildups or increased exposure to risk-sensitive investors.

### Recipient-country vulnerabilities amplify sensitivity
- Portfolio debt flows, especially those intermediated by investment funds, are significantly more sensitive to global risk in countries with:
  - weaker institutional quality;
  - lower official reserve buffers; and
  - higher public-debt-to-GDP ratios.
- These country-specific vulnerabilities amplify the retrenchment of nonresident flows during global risk-off episodes and can reinforce adverse macrofinancial dynamics (sovereign spreads, sovereign–bank nexus, domestic lending conditions, currency depreciation, balance-sheet mismatches).

---

### Heterogeneity across Investor Types and Behavior

### Nonresident versus resident investors
- Nonresident investors decrease their emerging market bond and equity investments significantly more than domestic investors when global risk rises:
  - Following a one-standard-deviation increase in the VIX, nonresident investors reduce their emerging market bond and equity investments by 0.6 percentage points more than resident investors.
  - This effect is economically meaningful, amounting to about one-third of the decline in nonresident NBFI emerging market investments during the COVID-19 shock in the first quarter of 2020.
- For advanced economy securities, nonresident nonbank investors do not react differently from resident investors.

### Responses by investor type
- Hedge funds are the most sensitive (flightiest), followed by other investment funds:
  - Nonresident hedge funds and mutual funds reduce their emerging market investments significantly more than resident investors do when market volatility rises.
  - Nonresident insurance companies and pension funds show no meaningful adjustment on average.
- The sensitivity of hedge funds is statistically significantly greater than that of mutual funds—likely reflecting greater use of leverage and forced asset sales when volatility spikes.
- Substantial heterogeneity exists across hedge funds and mutual funds: the flightiest quartile reduces emerging market holdings by more than twice the median response, while a significant share reacts less than resident holders.

### Structural vulnerabilities within investment funds
- Flightiness of investment funds is closely linked to structural vulnerabilities:
  1. Redemption pressures amplified by liquidity mismatches and risk-sensitive end investors.
  2. Use of leverage, which can trigger margin calls and liquidity spirals during volatility spikes.
  3. Benchmarking against major indices and common asset holdings that lead to correlated trading.
- Within the investment fund universe:
  - Nonresident passive funds and exchange-traded funds display markedly higher sensitivity than active mutual funds.
  - On average, no significant difference between institutional- and retail-focused funds, but notable heterogeneity exists within these categories.

---

### Policy Implications and Recommendations
- Strengthen supervisory and data frameworks to monitor private credit exposures and other NBFI activities, especially where private credit funds operate through opaque structures with limited oversight.
- Enhance surveillance of NBFI–bank linkages (credit lines, repos, derivatives, prime brokerage) to limit spillbacks to the banking system and reduce the risk of deleveraging-driven pullbacks of nonresident flows to emerging markets.
- Monitor and address vulnerabilities arising from reliance on banks for foreign exchange swaps and hedging—prepare to manage surges in hedging demand that can strain FX liquidity during global risk-off episodes.
- Track and regulate growing NBFI exposures to crypto-related assets and the use of stablecoins in cross-border transactions to mitigate contagion risks as crypto–NBFI linkages deepen.
- Build and maintain country-level buffers and institutional strength to reduce sensitivity of portfolio debt flows to global risk:
  - stronger institutional quality;
  - higher reserve adequacy;
  - prudent public-debt-to-GDP ratios.
- Recognize the higher flightiness of passive funds, ETFs, and leveraged vehicles (e.g., hedge funds) when designing macroprudential and liquidity-management tools to limit correlated trading and amplification of global risk shocks.

*Source: IMF staff analysis and figures from Chapter 2, "Capital Flows to Emerging Markets: The Role of Global Nonbank Investors," Global Financial Stability Report, April 2026.*

### CHAPTER 2 CApItAl Flows to EMErgIng MArkEts: thE rolE oF globAl nonbAnk InvEstors

### CHAPTER 2 CApItAl Flows to EMErgIng MArkEts: thE rolE oF globAl nonbAnk InvEstors

### Investor behavior and sensitivities to global risk
- Nonresident nonbank financial investors reduce emerging market investments more than resident investors when global risk rises (estimated using a one-standard-deviation increase in the VIX).
- Passive funds and exchange-traded funds tend to exhibit higher sensitivity to the VIX than active funds.
- Institutional-focused investment vehicles exhibit greater sensitivities to global risk; among passive funds, retail-focused vehicles tend to react more (difference not statistically significant at conventional levels).
- Investor redemptions are measured as net outflows from a fund, defined as valuation-adjusted declines in fund size.
- Passive funds and exchange-traded funds are more likely to pass investor redemptions through to underlying asset markets, reflecting more limited flexibility to use cash buffers to absorb outflows.
- Actively managed funds serving institutional clients can sometimes manage liquidity demands in periods of high global risk with limited asset sales.
- Investment funds use synthetic leverage and hedging:
  - Synthetically hedged funds, on average, do not reduce their emerging market investments as much as funds without identifiable synthetic exposures, suggesting hedging mitigates return volatility and redemption pressures.
  - Leverage effects are uneven and most pronounced among exchange-traded funds, consistent with mechanical rebalancing and reliance on margin financing, which can amplify shock transmission during stress episodes.

### Impact on asset classes and investor reallocation
- Institutional investors tend to rotate among asset classes when selling emerging market assets: moving out of corporate bonds into equities, and out of foreign-currency-denominated assets into local-currency-denominated assets.
- Leveraged funds are concentrated in equities; hedged funds are mainly invested in sovereign bonds.
- Synthetically leveraged funds hold substantially more emerging market assets than synthetically hedged funds (Figure 2.10 summary).

### Effects on issuance, spreads, and issuer behavior
- “Flighty” investors are defined as the top quintile of nonresident investors by global risk sensitivity (mainly hedge funds and mutual funds).
  - Flighty investors account on average for about 1 percent of emerging market bond markets, rising to as much as 14 percent in some countries.
- A one-percentage-point increase in the ex ante reliance on flighty investors implies:
  - a 28 percent decline in the volume of sovereign debt issuance during stress episodes, and
  - a 45 percent decline in the volume of corporate bond issuance during stress episodes.
- Sovereign and corporate spreads at issuance rise by about 30 and 120 basis points, respectively, during stress episodes for issuers with higher reliance on flighty investors.
  - These changes are economically sizable relative to average stress-period issuance spreads of 313 and 481 basis points.
- Sovereigns with greater ex ante reliance on flighty investors appear to increase domestic bond market issuance during stress; firms do not similarly substitute by increasing domestic bond issuance or syndicated loan issuance.
- Total debt of firms reliant on flighty nonresident investors seems to decline in periods of stress, and exposed firms appear to reduce capital expenditure significantly.
- Issuers with preexisting vulnerabilities (sovereigns with above-median public-debt-to-GDP ratios; firms with above-sector-specific median total-debt-to-total-equity ratios) experience a stronger and more persistent decline in issuance volumes during stress episodes.

### Secondary market amplification and historical episode
- Comparing similar emerging market securities differing in nonresident investor bases shows flightier investor bases can amplify price movements in stress episodes.
- Example: after the COVID-19 global risk-off shock, emerging market sovereign bonds with greater initial exposure to flighty nonresident investors experienced larger price declines than comparable bonds with a more stable investor base.

### Macrofinancial implications and growth-at-risk
- Reduced sovereign and corporate debt issuance and higher borrowing costs—particularly in economies with a flightier investor base—weaken domestic demand through lower consumption and investment, increasing downside risks to future growth.
- Using the left tail of the growth distribution (the 10th percentile) as a measure of downside risk:
  - In countries with greater ex ante reliance on flighty investors, a one-standard-deviation increase in the VIX lowers one-quarter-ahead (annualized) real GDP growth by an additional 6 percentage points relative to countries with lower reliance on flighty investors.
  - The differential effect remains negative for up to four quarters, on average, tapering off subsequently.

### Key statistics and model specifications (preserved values)
- Flighty investors account on average for about 1 percent of emerging market bond markets, rising to as much as 14 percent in some countries.
- One-percentage-point increase in reliance on flighty investors → 28 percent decline in sovereign bond issuance volume (stress episodes).
- One-percentage-point increase in reliance on flighty investors → 45 percent decline in corporate bond issuance volume (stress episodes).
- Sovereign spreads rise by about 30 basis points; corporate spreads rise by about 120 basis points (stress episodes).
- Average stress-period issuance spreads: sovereigns 313 basis points; corporates 481 basis points.
- A one-standard-deviation increase in the VIX lowers one-quarter-ahead (annualized) real GDP growth by an additional 6 percentage points in economies with greater reliance on flighty investors.
- Statistical significance and confidence:
  - Solid bars or circles in figures indicate statistical significance at 10 percent or lower.
  - Panels and regressions include issuer–security type–time fixed effects, fund–issuer–security type fixed effects, and controls such as lagged fund size and returns, portfolio-weighted country-level pull factors, and a large set of bond-, firm-, and country-level controls where applicable.

*Source: CHAPTER 2 CApItAl Flows to EMErgIng MArkEts: thE rolE oF globAl nonbAnk InvEstors (IMF, April 2026).*

### Conclusions and Policy

### Conclusions and Policy

### Investor composition and sensitivity to global risk
- Cross-border portfolio flows to emerging markets, driven largely by nonbank investors, have risen sharply since the global financial crisis.
- Sensitivity to shifts in global risk depends critically on the composition and structure of the investor base.
- Hedge funds and investment funds react more strongly to shifts in global risk than other nonbanks.
- Within investment funds, passive mutual funds and exchange-traded funds are generally the most sensitive to shifts in global risk.
- The share of flighty investors is constructed by estimating each investor’s sensitivity to the VIX and, for each emerging market bond market, computing the share held by the top quintile of nonresident investors with the highest sensitivity.
- Greater reliance on flighty investors may increase downside risks to growth (figure notes describe impacts on the 10th percentile of future real GDP growth distribution after a one-standard-deviation increase in the VIX).

### Policy frameworks and resilience
- Robust policy frameworks can mitigate the impact of adverse global shocks:
  - Nonbank investors are less responsive to an increase in global risk in countries with stronger institutions, ample reserve buffers, and lower fiscal risks.
  - Strengthening fiscal positions and external buffers can reduce the risk of capital flow reversals and improve a country’s capacity to absorb external shocks, particularly where external financing needs are large.
  - Maintaining credible and robust policy and institutional frameworks is important to attract stable, long-term investors.
- Systemwide stress tests:
  - Use systemwide stress tests to gauge the resilience of the domestic financial system to sudden capital flow reversals driven by nonresident investors.
  - Expand systemwide stress testing in source countries to include major nonbank financial intermediaries to help assess spillovers and strengthen monitoring and mitigation of potential cross-border risks.
- Proactive risk management:
  - In the face of adverse financial shocks and capital flow volatility, countries should engage in proactive risk management through macroeconomic and macroprudential tools, consistent with the IMF’s Integrated Policy Framework.
- Macroprudential and capital flow management tools:
  - The desirability of deploying specific macroprudential or capital flow management tools or of foreign exchange intervention depends on whether they address frictions such as destabilizing premiums from arbitrage frictions in shallow FX markets, foreign currency mismatches on corporate balance sheets, and exchange rate changes that risk de-anchoring inflation expectations.

### Liquidity management, transparency, and fund structure
- The flightiness of institutional investors is closely linked to structural vulnerabilities:
  - Redemption risk, the use of leverage, and benchmarking practices increase institutional investor flightiness.
- Surveillance priorities:
  - Monitor not only aggregate volume of flows but also composition—share held by passive or leveraged funds and extent of hedging—since these features shape the likelihood of synchronized outflows under stress.
- Policy actions to mitigate correlated asset sales:
  - Strengthen liquidity management of investment funds.
  - Enhance transparency around leverage and derivative use.

### Deepening domestic markets and investor base
- To reduce vulnerability to volatile cross-border portfolio flows, emerging markets should:
  - Continue to deepen domestic local-currency bond markets.
  - Broaden the domestic investor base to include long-term institutional investors (pension funds, insurers, domestic mutual funds).
- More developed local bond markets can provide a stable alternative source of financing when external funding conditions tighten.
- A more diversified investor base can help mitigate the amplification of global financial shocks.

### International cooperation and data sharing
- International cooperation is key to limiting propagation and amplification of global financial shocks:
  - Jurisdictions may not internalize cross-border spillovers of their regulatory frameworks; regulatory gaps in source countries can transmit vulnerabilities across borders.
  - Coordinated policy action that mitigates NBFI vulnerabilities—such as implementing liquidity management tools for open-end mutual funds—can help contain shock transmission and reduce global financial instability risk.
- Closing data gaps:
  - Most information on asset holdings of nonbank financial investors is collected in source countries, limiting emerging market supervisors’ ability to assess exposures across investor types.
  - Data gaps on key vulnerabilities, including leverage and exposure to derivatives, constrain risk assessment.
  - Improved regulatory reporting and international data sharing would help recipient countries monitor systemic risk and source countries assess potential cross-border spillovers more effectively.

### Private credit in emerging markets
- Opportunities and risks:
  - Private credit can support growth and deepen financial intermediation by providing bespoke credit solutions to borrowers underserved by banks.
  - Rapid expansion of private credit could generate financial stability risks if it amplifies leverage or operates with limited transparency, especially where supervisory and data frameworks are less developed.
- Recent trends and size:
  - Industry data suggest that emerging markets account for a single-digit share of the global total (less than 5 percent).
  - Deal activity accelerated from about $14 billion in 2024 to more than $22 billion in 2025.
  - Recent estimates place emerging market private credit assets under management between roughly $50 billion and $100 billion, representing a fivefold increase over the past decade.
  - About half of the total is attributed to India, with the rest mostly split between Latin America and China.
- Market structure:
  - Global managers tend to operate through offshore hard-currency funds, place FX risk on borrowers, and target larger companies and deal sizes.
  - Domestic managers rely on locally domiciled vehicles with significant participation from domestic institutional investors and retail capital, enabling them to provide local-currency credit to smaller borrowers.
- Policy and supervisory reforms needed:
  - Stronger restructuring and insolvency regimes.
  - Clearer collateral-enforcement frameworks.
  - Revised allocation limits for domestic institutional investors.
  - Improved transparency on fund leverage, valuation practices, and interconnections.
  - Strengthened supervisory and data frameworks to enable timely risk assessment, especially where borrowers have weaker credit profiles.

### Stablecoins and cross-border crypto flows
- Stablecoin trends and scale:
  - Gross cross-border flows in the two largest dollar-pegged stablecoins—Tether (USDT) and USD Coin (USDC)—rose from an estimated $12 billion in the first quarter of 2020 to $316 billion in the first quarter of 2025.
  - A large share of these flows has been directed toward emerging markets; cumulative net inflows have accelerated since late 2023.
  - Stablecoin gross flows have reached double-digit shares of annual GDP for Ukraine, Vietnam, and Belarus.
  - Net flows are considerably smaller at just under 1 percent of annual GDP in the largest recipients, consistent with stablecoins being used to facilitate transactions.
- Drivers of inflows:
  - Stablecoin flows comove most strongly with unbacked crypto activity in a country, consistent with settlement use within the crypto ecosystem.
  - Inflows also correlate significantly with remittance and trade flows.
  - Inflows are larger for countries with weaker institutional and political stability and without access to short-term dollar assets in the form of money market funds.
  - Greater stablecoin adoption is associated with variables related to currency-substitution motives: inflows are larger in countries with higher inflation and greater exchange rate volatility.
  - Inflows comove with global funding conditions and crypto market conditions: inflows decrease when global funding costs are higher and increase with global risk aversion (measured by the VIX) and Bitcoin price volatility.
- Risks and policy implications:
  - Absent adequate regulation and backstops, stablecoins may pose risks to macrofinancial stability via run risk and potential spillovers to traditional financial markets and the real economy.
  - Growing adoption could lead to currency substitution, adverse consequences for monetary policy transmission, greater pass-through of global financial conditions, increased capital flow volatility, and circumvention of capital flow management measures.
  - Risks can be more acute as stablecoins scale relative to a country’s macroeconomy and become more deeply integrated with the broader financial system.
  - Policy priorities should be proportionate, country specific, and embedded within broader efforts to strengthen oversight of nonbank credit intermediation.
  - Enhanced regulatory oversight and contingency planning are warranted given growing NBFI exposure to crypto assets and rapid adoption of stablecoins in emerging markets.

*Source: ch2 - Conclusions and Policy — https://www.imf.org/-/media/files/publications/gfsr/2026/april/english/ch2.pdf*

### Annex 2.6 for additional details. AEs = advanced economies; BTC = Bitcoin; EMs = emerging markets; ETH = Ethereum; FX = 

### Box 2.2 (continued)

### Key points on stablecoins and cross-border linkages
- Stablecoins exhibit safe-haven behavior similar to that observed for the dollar (October 2025 Global Financial Stability Report).
- Such linkages could strengthen the cross-border transmission of global financial shocks and crypto shocks.
- Higher values of Inst. & pol. stability indicate greater institutional and political stability.
- Acronyms used: AEs = advanced economies; BTC = Bitcoin; EMs = emerging markets; ETH = Ethereum; FX = foreign exchange; MMF = money market fund; USDC = USD Coin; USDT = Tether; VIX = Chicago Board Options Exchange Volatility Index.

### Policy implications
- Potential benefits and risks associated with stablecoins call for well-calibrated policies that preserve benefits while mitigating key risks.
- From a prudential perspective, proportionate oversight of stablecoin access and exposures by relevant intermediaries and financial institutions, together with robust anti–money laundering/combating the financing of terrorism measures consistent with international standards, can help mitigate relevant risks. 5
- Given the cross-border nature of stablecoin flows:
  - Close international coordination is needed to address spillover risks.
  - Harmonize regulatory standards to limit regulatory arbitrage.
  - Fill in data gaps.
  - Maintain open channels for effective supervisory and policy dialogue.
- Sound macroeconomic policies alongside continued financial system development are essential to address macro fragilities and structural frictions that may lead to currency substitution pressures. 5

### Progress on regulatory and supervisory frameworks
- While countries have taken steps to develop supervisory frameworks for stablecoins, progress has remained slow and fragmented.
- Fragmentation reflects limitations in existing regulatory mandates and tools, as well as the cross-border nature of stablecoin activity.
- For details on progress, see FSB (2025b).

*International Monetary Fund | April 2026*

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_Source: https://www.imf.org/-/media/files/publications/gfsr/2026/april/english/ch2.pdf_