Credit IMF Photo/James Mertz
Credit IMF Photo/James Mertz
Emerging market economies have held up remarkably well in recent years, even after periods of global financial turbulence. While favorable external conditions (in other words, good luck) often helped, it’s clear that good policies matter.
In the past, “risk-off” episodes—when global investors indiscriminately sold riskier assets—often hit emerging markets especially hard. They triggered sharp capital outflows and tighter financial conditions, causing currencies to plunge and inflation to surge.
That picture has significantly changed recently. Many emerging markets have weathered shifts in global risk appetite better than before. Capital outflows have been smaller, borrowing costs more contained, growth steadier, and inflation lower.
Improved policy frameworks—such as credible monetary policy, more independent central banks and more transparent fiscal policy—played an important role, as we show in a chapter of the new World Economic Outlook. Comparing typical risk-off episodes before and after the global financial crisis, our analysis concludes that improved policy frameworks contributed to smaller output losses and lower inflation.
Better frameworks also improved confidence and trust among investors. Local currency bond markets have deepened in many emerging markets, contributing to greater financial resilience. This helped reduce both currency mismatches and the risk of sudden capital outflows.
Yet risks remain: external conditions can quickly deteriorate, recent global shocks have eroded fiscal space, the post-pandemic inflation surge has pushed up inflation expectations, and political pressures could undermine hard-won credibility.
The presence of fiscal rules has also not prevented the buildup of debt in many emerging market economies—in large part due to limited compliance with the rules. The result: debt structures and vulnerabilities to global shocks differ widely across countries, as we discuss in the new Global Financial Stability Report.
Improved frameworks
Our analysis shows that monetary policy implementation has improved, and the credibility of central banks has strengthened. In the past, many emerging economies were reluctant to let their exchange rates move freely. But with better-anchored inflation expectations and stricter macroprudential regulation, countries have increasingly allowed the exchange rate to act as a shock absorber, and central banks could shift their focus toward stabilizing economic activity.
Meanwhile, central banks have bolstered their independence—both from fiscal dominance (when monetary policy had to accommodate fiscal needs) and from US monetary policy that determined domestic borrowing conditions. That means countries can now rely less on costly foreign exchange interventions.
Emerging markets have also made significant improvements to fiscal frameworks, which enabled governments to respond more effectively to shortfalls in demand. This has helped stabilize economies during global downturns and respond more forcefully whenever higher debt and interest rates pose a risk.
Comparing risk-off episodes before and after the global financial crisis shows that economic output was 1 percentage point higher than it would have been otherwise, with improved frameworks explaining slightly more than 0.5 percentage point, and favorable external conditions accounting for the rest. Inflation was 0.6 percentage points lower, thanks to the more effective policies.
Financial resilience and risks
But, here too, strengthened policies have helped.
Large emerging markets with strong policy frameworks and growing domestic savings have been able to rely more on local currency debt issuance and strong demand from domestic investors, especially nonbank financial institutions. As a result, the share of debt issued in local currency and owned by foreign investors has fallen to multiyear lows in many countries.
Greater domestic ownership of local currency debt reduces the sensitivity of emerging market debt to global shocks, according to new analysis in the Global Financial Stability Report. With more domestic ownership, bond yields rise less than they would otherwise in a risk-off scenario.
The stabilizing effect of domestic investors on bond yields appears to be especially true for banks. Our analysis shows that a risk-off shock is associated with a 19-basis-point increase in local currency yield spreads, but a one-standard-deviation increase in domestic bank ownership share mitigates that effect to 11 basis points. Greater ownership by domestic nonbank financial institutions can also be beneficial under certain circumstances.
However, improved financial stability and resilience have not been evenly shared. Smaller emerging markets and frontier economies have needed to rely on more expensive and less stable forms of financing, such as short-term domestic debt and international US dollar bonds. Efforts to further deepen local currency bond markets across a broader spectrum of countries would help build resilience.
Higher domestic ownership is also not without risks. In countries with low savings, narrow investor bases, and poor financial market infrastructure, excessive sovereign debt holdings can lead to problems. For example, large holdings of sovereign debt by banks can reduce their capacity to lend to the private sector, which may in turn reduce economic growth. In addition, sovereign defaults can lead to large losses in the banking sector, ending in expensive and difficult bank bailouts.
Continued commitment
Even though recent experiences have been encouraging, emerging markets will continue to be tested because uncertainty remains elevated. Progress across countries has been uneven and fiscal space is stretched in some cases.
Countries should prioritize efforts to improve the implementation and credibility of their policy frameworks, preserve central bank independence, and rebuild spending capacity for when it is needed (for example during an economic downturn). IMF capacity development can also help support local currency bond market development.
With continued reforms and stronger foundations, emerging markets can turn hard-won resilience into long-lasting stability.
—This blog is based on Chapter 2 of the October 2025 World Economic Outlook, “Emerging Market Resilience: Good Luck or Good Policies?” and Chapter 3 of the Global Financial Stability Report “Global Shocks, Local Markets: The Changing Landscape of Emerging Market Sovereign Debt.”
