Investing in Emerging Markets Less Risky Than Perceived, New Study Reveals

New data from the Global Emerging Markets Risk Database (GEMs) is reshaping perceptions of lending risks in developing economies. A comprehensive analysis released by the International Finance Corporation (IFC) in October 2024 reveals that lending to private companies in emerging markets may not be as hazardous as traditionally believed. The research, based on around 15,000 loans issued over the past three decades by multilateral development banks (MDBs) and development finance institutions (DFIs), covers a wide array of sectors and geographies and offers one of the most in-depth views yet of default and recovery patterns in the private credit space of developing economies.

Rethinking the Risk Narrative

For decades, investors have treated emerging markets with significant caution, driven by fears of macroeconomic instability, political risk, and limited data transparency. The lack of robust statistics on borrower defaults and recoveries has only deepened this perception. However, the GEMs consortium, which includes 26 MDBs and DFIs, has pooled credit risk data to fill this gap, providing a clearer picture of actual investment performance across emerging markets. The results are surprisingly reassuring. The average annual default rate for loans to private counterparties across emerging markets was 3.6 percent between 1994 and 2023. This figure aligns closely with default rates of globally rated, non-investment-grade companies, 3.3 percent for “B”-rated entities by S&P and 4.0 percent for Moody’s “B3” ratings. Given that GEMs borrowers are mostly located in developing countries, these comparable rates suggest that such investments are no more prone to failure than similar-risk loans in advanced economies.

Diversification in Action

Perhaps even more compelling is the evidence that emerging market defaults do not always move in lockstep with those in advanced economies. This lack of perfect correlation, 0.46 with S&P’s B-rated firms and 0.33 with Moody’s B3-rated firms, indicates that economic shocks in advanced countries do not necessarily trigger similar levels of distress in emerging markets. The diversification benefit is real. For instance, during the 2008 global financial crisis, which hit developed economies hard, default rates among emerging market firms were relatively restrained. This implies that portfolios combining assets from both developed and developing markets could help investors mitigate systemic risk during global downturns.

Income Doesn’t Tell the Whole Story

Digging deeper into the data by income level, the GEMs statistics reveal a gradient of default risk aligned with national income levels, but again, the results are more moderate than conventional wisdom might suggest. Default rates in high-income countries averaged 2.3 percent, while those in low-income nations reached 6.3 percent. Interestingly, in every income category except high-income countries, the observed default rates in the GEMs data were lower than the risk levels implied by sovereign credit ratings. In low-income countries, the difference was particularly stark: GEMs-based default rates were 7.9 percentage points lower than those projected by sovereign ratings. This finding challenges the heavy reliance on sovereign ratings as proxies for corporate risk in low-income countries and suggests that lending to private firms, particularly with support from MDBs and DFIs, carries less risk than sovereign-level metrics would indicate. It also highlights the potential overpricing of risk by investors who do not distinguish between sovereign and firm-level exposures.

Better Than Expected When Things Go Wrong

Recovery rates after defaults further bolster the case for emerging market investments. The average recovery rate across the GEMs portfolio was 72 percent, surpassing Moody’s global loan recovery rate of 70 percent, and significantly outperforming recoveries from Moody’s global bonds (59 percent) and JPMorgan’s emerging market bonds (38 percent). These robust outcomes may reflect the active engagement of MDBs and DFIs, which often offer advisory services, in-country supervision, and strong borrower relationships that enhance repayment prospects even in distressed situations.

A Wake-Up Call for Global Investors

The implications of these findings are far-reaching. They suggest that investments in emerging market firms, particularly those structured or co-financed by development institutions, may offer returns with risk profiles comparable to high-yield investments in advanced economies, but with the added benefit of diversification. For investors looking to broaden their exposure without taking on excessive risk, this research provides a data-backed incentive to reconsider long-standing assumptions. The extensive involvement of development institutions, with their ability to provide project-level support and enforce governance standards, appears to significantly mitigate the risks that dominate investor concerns. While GEMs data is not a mirror image of commercial portfolios, since development banks often take a more engaged role, it does offer a strong counterpoint to the narrative that emerging markets are too unpredictable or dangerous for private lending. On the contrary, with informed investment strategies and the right institutional partnerships, emerging market lending may be far more prudent than previously imagined.