Emerging Market Borrowers: Resilient Against Global Economic Uncertainty

Emerging market companies have shown resilience against global interest rate fluctuations by adapting borrowing strategies, increasing local currency debt, and maintaining financial stability despite rising costs. However, challenges remain as high global interest rates and corporate leverage pose future risks.

Research authored by John Gandolfo and Paolo Mauro and published by the International Finance Corporation (IFC), explores how companies in emerging economies have managed to remain resilient despite significant fluctuations in global interest rates since 2019. The report draws insights from key financial institutions such as JP Morgan, Bloomberg, the St. Louis Federal Reserve, the International Monetary Fund (IMF), and Refinitiv to examine borrowing trends, corporate debt structures, and financial stability. Over the past five years, interest rates have swung dramatically, largely influenced by the COVID-19 pandemic and subsequent macroeconomic shifts. Before the crisis, interest rates in developed economies were at record lows, with some government bonds even yielding negative returns. However, the financial landscape changed dramatically in March 2020 when central banks, including the U.S. Federal Reserve, responded to global uncertainty by flooding markets with liquidity. This led to an initial drop in yields, followed by a sharp tightening cycle as inflation surged worldwide. Despite these fluctuations, emerging market corporations have shown remarkable resilience, with borrowing costs rising in line with U.S. Treasury yields but without significant widening of spreads. Unlike previous crises, such as the Latin American debt crisis of the 1980s, the Asian financial crisis of 1997, the Russian default of 1998, and the 2013 taper tantrum, emerging market companies have been better prepared to withstand macroeconomic shocks.

The Shift Toward Local Currency Borrowing

A significant trend in emerging markets has been the increased preference for borrowing in local currencies instead of U.S. dollars. This marks a major departure from previous financial crises, where foreign currency-denominated debt left firms vulnerable to exchange rate fluctuations. Countries with deep domestic capital markets, such as India, have seen a surge in local-currency bond issuances, allowing businesses to reduce exposure to volatile foreign exchange risks. However, this shift is not universal. In lower-income and smaller emerging markets, firms still rely heavily on foreign currency borrowing due to the underdevelopment of local financial systems. This leaves them more exposed to exchange rate depreciation and external financial shocks. As global interest rates remain above pre-pandemic levels, firms that continue to depend on foreign-denominated debt may face increasing refinancing risks.

Rising Borrowing Costs and Financial Adaptability

Since the pandemic, borrowing costs for emerging market firms have increased, but at a pace similar to or even slower than their counterparts in advanced economies. For instance, corporate bond yields in emerging markets rose from 4.8% in December 2019 to 6.4% in September 2024, whereas U.S. investment-grade corporate bond yields increased from 2.7% to 4.7% in the same period. However, borrowing costs remain largely dependent on a country’s income level. In high-income emerging markets, corporate bond yields rose from 4.7% to 6.4%, while upper-middle-income firms saw an increase from 5.6% to 6.9%. The most significant jump was observed in lower-middle-income corporates, where yields surged from 5% to 7.3%. Interestingly, in certain lower-middle-income countries such as Egypt and Ghana, some corporate bonds were perceived as less risky than sovereign bonds, indicating that investors viewed these companies as more financially stable than their governments.

Maintaining Financial Health Amid Rising Debt

Despite the increased cost of borrowing, emerging market companies have maintained financial stability, primarily due to strong corporate earnings and effective debt management. The interest coverage ratio, which measures a company’s ability to cover interest payments with earnings, has remained at levels comparable to those before the pandemic. This suggests that while firms are paying more for debt, profitability has kept pace, preventing widespread financial distress. However, some risks remain. First, global interest rates are expected to remain higher than pre-pandemic levels, which could drive up refinancing costs for firms with debt maturing in the coming years. Second, corporate leverage has increased significantly over the past decade, making companies more sensitive to financial shocks. Lastly, persistently high borrowing costs could lead to lower capital investments, limiting long-term growth in emerging markets.

The Future of Emerging Market Borrowers

The financial outlook for emerging market companies will depend heavily on macroeconomic stability, global interest rate trends, and corporate profitability. While firms have adapted well to recent financial shocks, sustaining this resilience will require sound economic policies and proactive financial strategies. The shift toward local currency borrowing is a promising development that reduces exposure to foreign exchange risks, but it is not an option for all firms, especially those in countries with underdeveloped financial markets. Nations that strengthen their domestic capital markets will be better positioned to help businesses reduce dependency on foreign debt and improve financial sustainability. The report concludes on a cautiously optimistic note, emphasizing that while emerging market companies have weathered recent economic storms, persistent inflation, elevated interest rates, and geopolitical uncertainties pose ongoing challenges. The ability of companies to sustain profitability and adapt to financial headwinds will ultimately determine their resilience in the years ahead.