## Emerging Markets’ Two-Way Traffic

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**Canonical URL:** [Emerging Markets’ Two-Way Traffic](https://www.imf.org/en/publications/fandd/issues/2024/12/point-of-view-emerging-markets-two-way-traffic-david-lubin)

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## Bibliographic details
- Authors: DAVID LUBIN
- Published: December 3, 2024

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### Central thesis
- Financially fragile emerging market and developing economies are pursuing disciplined, market-friendly reforms to eliminate vulnerabilities.
- Some stronger, more historically stable emerging market economies are adopting looser fiscal or macroeconomic policies that could erode public-sector balance sheets and raise country risk premiums.
- Label used in the piece: “two-way traffic” in emerging markets.

### Evidence from financial markets
- Credit spreads of fragile-but-improving countries have narrowed disproportionately.
- In the first nine months of 2024, sub-investment-grade dollar-denominated sovereign debt in emerging markets returned more than 15 percent.
- In the first nine months of 2024, investment in more creditworthy countries returned less than 5 percent.
- High-yield bonds can outperform investment-grade assets by more than 10 percentage points in the first nine months of a calendar year; over the past three decades this has happened only three times: 1999, 2003, and 2009.
- Stock of sovereign debt in default was a mere half percent of global GDP last year, according to a database on sovereign default maintained by the Bank of Canada and the Bank of England.
- By contrast, in the late 1980s the stock of defaulted debt was more than 2 percent of global GDP.

### Fiscal and policy adjustments — examples and magnitudes
- Fragile economies undertaking ambitious fiscal adjustments:
  - Argentina: aiming to turn a primary budget deficit of 3 percent of GDP in 2023 into a 1 percent surplus next year.
  - Egypt: targeting a primary surplus of 5 percent in the fiscal year ending June 2027.
  - Türkiye: plans to turn a primary deficit of 2.6 percent of GDP in 2023 into a surplus of 0.5 percent of GDP next year.
- Countries leaning toward looser policies despite stronger balance sheets:
  - Mexico: President Claudia Sheinbaum inherited a 2024 budget deficit of some 6 percent of GDP, the largest since 1989.
  - Brazil: market concerns that fiscal loosening under President Luiz Inácio Lula da Silva could be incompatible with financial stability despite a Moody’s sovereign upgrade.
  - Indonesia: President Prabowo Subianto has raised the prospect of letting the debt-to-GDP ratio rise to 50 percent, up from 39 percent at present.

### Drivers and structural context
- Two contrasting forms of globalization:
  - Financial globalization: created volatile capital flows in recent decades but many developing economies now manage flow and stock vulnerabilities better.
    - Policy lessons emphasized: keep current account deficits within limits (limit flow vulnerability) and accumulate foreign exchange reserves (limit stock vulnerability).
  - Real globalization: trade growth has been weak versus GDP growth over the past two years and much of the past decade; rising global trade hostility could reduce export reliability as a growth path.
- The weakening external trade environment may encourage fiscally healthier countries to use accumulated reputational capital to support domestic demand, especially to finance climate transition and national defense needs.

### Risks, scenarios, and implications
- If fiscal easing in healthier countries is:
  - Moderate, productivity-boosting, and adds to potential growth → may not alarm markets and two-way traffic could be benign.
  - Large or poorly targeted, especially amid a steeper or protracted collapse in global trade → public-sector balance sheets could deteriorate further and markets would likely demand higher rates to supply credit.
- The future trajectory of global trade is a key determinant of whether emerging markets broadly embrace market-friendly reform or shift toward looser policies.

### Concluding observations
- The current pattern differs from past episodes where high-yield outperformance followed major crises; here, outsized returns for fragile-but-improving issuers have occurred without a recent major financial crisis.
- The observed policy divergence reflects both improved crisis management (self-insurance through reserves and constrained current account deficits) and pressures from weakening real globalization that incentivize fiscal support for domestic priorities.

*Source: Emerging Markets’ Two-Way Traffic, F&D Magazine, DAVID LUBIN, December 2024.*

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## Content in this bundle

- **Emerging Markets' Two-Way Traffic**
  - [Emerging Markets' Two-Way Traffic (Markdown version)](/-/media/files/publications/fandd/article/2024/12/pov-lubin.pdf.md){rel="alternate" type="text/markdown"}
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_Source: https://www.imf.org/en/publications/fandd/issues/2024/12/point-of-view-emerging-markets-two-way-traffic-david-lubin_