In a constantly evolving global financial environment, emerging markets present both promising opportunities and complex challenges. Characterized by rapid growth, young populations and developing financial systems, these economies offer an attractive proposition for investors seeking diversification and potentially high returns, but also carry complex risks.
Through insights from the public and private sectors, this edition of the Bulletin explores the case for investing in emerging markets, the challenges involved, and the role of multilateral and domestic actors in facilitating investment in key sectors.
Emerging markets now account for more than half of the world’s gross domestic product, and their importance to the global economy is undeniable. Here are some reasons why investors should reconsider their emerging market allocations: Massimiliano Castelli and Philippe Salman, heads of global sovereign markets strategy and advice at UBS Asset Management, said: They point to the positive growth differential between emerging and developed markets, increasing macroeconomic stability, and improving policy management. In terms of asset allocation, they also “expect emerging market assets to outperform over the next decade, with emerging market debt (denominated in hard currencies) generating higher annual returns than global equities (which have lower volatility).”
The maturation of emerging market fixed income markets has given rise to sub-asset classes worth approximately $4 trillion, providing diversified investment avenues across various sectors. Jeremy Cunningham, investment director at Capital Grouphighlights the strategic need to consider allocations to local currency debt in emerging markets, noting that local currency debt in emerging markets benefits from diversification, a variety of debt instruments, improved liquidity and the potential for higher returns.
However, investing in emerging markets carries high risks, including currency fluctuations, political uncertainty and sovereign defaults, that require extensive research and active management.
However, the global macroeconomic environment plays a key role in shaping the investment outlook in emerging markets. Jeffrey Schultz, chief economist for Central and Eastern Europe, the Middle East and Africa at BNP Paribas Emerging market growth is being bolstered by strong economic activity in the United States and a modest recovery in Europe, which it says will help offset a weakening Chinese economy. But inflation remains a concern, with some forecasters predicting central banks may not be able to meet their targets until 2025.
In addition to more complex trade-offs, fiscal policy in emerging markets is expected to become more important, especially following key elections in these countries. Recent elections in South Africa, Mexico and India have tested investors’ nerves, he said. Christopher Smart, Managing Partner of Arbroath Group He writes about the delicate balance between voter demands and market constraints. These political shifts could lead to populist policies that undermine fiscal and monetary stability, leading to increased deflation and affecting asset prices.
To reduce the risk: Jun Park, Senior Manager, Blended Finance, International Finance Corporationexplains how blended finance reduces risk and mobilizes larger amounts of private capital in emerging markets. He writes, “By absorbing risks that private investors are unwilling to take on, blended finance multiplies the impact of limited public resources and mobilizes larger amounts of private capital.”
Similarly, Manfred Scheppers, CEO of ILX Fund Iexplains that multilateral development banks are well-positioned to address emerging market challenges because of their investment experience, local networks, sector expertise and financial capacity. Institutional investors can greatly benefit from this expertise, as “co-lending with MDBs is not only a necessity but also a smart business decision,” especially in the area of climate finance.
While multilateral actors can go a long way in facilitating investment in emerging markets, domestic institutions and policy environments are also crucial. Deputy Director General of the Indonesian Investment Board, Arif Budiman, said: He highlighted the role of sovereign wealth funds in attracting global institutional investors to emerging markets, pointing out, for example, how INA acts as a co-investor, leveraging local knowledge and networks to facilitate investment from global partners focusing on areas such as the energy transition and digital infrastructure.
In India, K. Mukundan, Strategic Initiatives and Policy Advisor, National Investment and Infrastructure Fund He highlighted the opportunities arising from the country’s greening and energy transition, which is supported by policy incentives and infrastructure development. “India’s focus on both economic growth and environmental protection has established it as a global leader in sustainable development,” he noted, making it an attractive investment destination.
Investing in emerging markets offers attractive opportunities for growth, diversification and impact. But these opportunities come with significant challenges, including political risk, economic instability and a complex regulatory environment. To navigate this space, investors need to adopt a nuanced approach that combines thorough risk management with strategic partnerships. Blended finance and collaboration with development finance institutions offer a promising avenue to mitigate risk and unlock the full potential of emerging markets.
Arunima Sharan is a Senior Economist at OMFIF’s Institute of Economics and Monetary Research.
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