Emerging Markets Navigate Global Interest Rate Volatility

IMF Blog, January 31, 2024

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Global interest rates have been volatile, especially on longer-term government bonds.
Yields on 10-year US Treasuries are climbing again after pulling back from a 16-year high of 5 percent in October.
Interest rate moves in other advanced economies had been equally prodigious.
Emerging market economies saw much milder rate moves during the recent period.

Average sensitivity to US interest rates of 10-year sovereign yields declined:
- Latin American emerging markets: declined by two-thirds during the current tightening cycle compared with the taper tantrum in 2013.
- Asian emerging markets: declined by two-fifths during the current tightening cycle compared with the taper tantrum in 2013.
Exchange rates, stock prices, and sovereign spreads fluctuated in a modest range.
Foreign investors did not leave emerging market bond markets, in contrast to past episodes (including 2022) where large outflows ensued.
Global financial conditions remained quite benign during the current global monetary policy tightening cycle, especially last year—contrasting with previous hiking episodes in advanced economies that were accompanied by much more pronounced tightening of global financial conditions.

Policy framework improvements:
- Many emerging markets have enhanced central bank independence, improved policy frameworks, and gained progressively more credibility.
- Central banks tightened monetary policy in a timely manner since the pandemic and brought inflation toward target.
Monetary policy divergence and rate hikes:
- During the post-pandemic era, many central banks hiked interest rates earlier than counterparts in advanced economies.
- On average, emerging markets added 780 basis points to monetary policy rates compared to an increase of 400 basis points for advanced economies.
- The wider interest differentials created buffers that helped keep external pressures at bay.
Structural and market developments:
- Additional currency reserves built over the last two decades.
- Many countries refined exchange-rate arrangements and moved towards exchange-rate flexibility.
- Structure of public debt became more resilient.
- Domestic savers and domestic investors became more confident investing in local-currency assets, reducing reliance on foreign capital.
- Rise in prices of commodities during the pandemic helped external positions of commodity-producing emerging markets.

Dollar returns on emerging market assets lagged similar advanced-economy assets during the high-rate environment:
- Emerging market bonds for high-yield, or lower-rated, issuers have returned about zero percent on net over the past four years.
- US high-yield bonds have provided 10 percent over the same period.
- Private credit loans provided by nonbanks to lower-rated US companies have returned even more.
The sizable differences in returns may reduce emerging markets’ external financing prospects as foreign investors with cross-asset mandates can find more-profitable alternatives in advanced economies.

Three challenges stand out for major emerging markets:
- Interest rate differentials are narrowing as some emerging markets are anticipated by investors to cut rates faster than advanced economies, which could entice capital to leave emerging market assets in favor of assets in advanced economies.
- Quantitative tightening by major advanced economies continues to withdraw liquidity from financial markets, which could additionally weigh on emerging market capital flows.
- Global interest rates remain volatile as investors—reacting to central banks emphasizing data-dependency—have grown more attentive to surprises in economic data. Market projections that central banks in advanced economies will materially cut rates this year are perilous for emerging markets if those projections prove wrong and investors reprice in higher-for-longer rates.
A slowdown in emerging markets, as projected by the latest World Economic Outlook update, transmits via both trade and financial channels.
More borrowers globally are defaulting on loans, weakening banks’ balance sheets; emerging market bank loan losses are sensitive to weak economic growth (as shown in a chapter of the October Global Financial Stability Report).

Frontier emerging markets and lower-income countries face greater challenges, primarily the lack of external financing.
Borrowing costs are still high enough to effectively prohibit these economies from obtaining new financing or rolling over existing debt with foreign investors.

Emerging markets continue to see significantly higher expected growth rates than advanced economies.
Capital flows to stock and bond markets remain strong in many cases.
Policy frameworks are improving in many countries.
The resilience of major emerging markets since the pandemic may continue, supported by the above factors.

Central banks in emerging markets should:
- Continue to commit to inflation targeting while remaining data dependent in their inflation objectives.
- Keep monetary policy focused on price stability.
Use the full spate of macroeconomic tools to fend off external pressures, with the IMF’s Integrated Policy Framework providing guidance on the use of currency intervention and macroprudential measures.
Frontier economies and low-income countries should:
- Strengthen engagement with creditors—including through multilateral cooperation.
- Rebuild financial buffers to regain access to global capital.
Countries with credible medium-term fiscal plans and monetary policy frameworks will be better positioned to navigate periods of global interest rate volatility.

Source: Emerging Markets Navigate Global Interest Rate Volatility; Tobias Adrian, Fabio Natalucci, Jason Wu; January 31, 2024.

Chapter 1
- Chapter 1 (Markdown version)
- Chapter 1 (PDF)
January 2024 WEO Update — Key Findings
- January 2024 WEO Update — Key Findings (Markdown version)
- January 2024 WEO Update — Key Findings (PDF)