Geopolitical tensions are elevated between the U.S. and Iran as well as between Russia and Ukraine, creating risks to energy supplies and contributing to higher energy prices. Despite this, EM economic fundamentals have demonstrated resilience, with reasonable growth rates, manageable inflation, firmly positive real interest rates, and limited external financing needs, supported by ample foreign-currency reserves. Among EM countries, credit rating upgrades have outpaced downgrades for the past three years.
EM central banks have been prudent, maintaining policy rates above inflation. This approach has served policymakers well; barring a few cases, central banks have been able to take a measured approach to external developments. We anticipate that inflation pressures will be contained, in particular if EM currencies remain on a solid footing. Near-term risks may come from potential changes to the U.S. Federal Reserve's policy approach under its new chairman and the economic consequences of a developing El Niño climate pattern.
Renewed investor interest in diversification has supported EM assets. Investor flows and primary markets have been steady in the face of geopolitical and commodity price volatility. Over the long term, structural forces continue to benefit EM debt, including stronger growth prospects relative to developed markets and a widening opportunity set across nearly 90 countries, spanning sovereign, corporate, and local-market bonds. In our view, EM debt offers value as a strategic allocation, with attractive yields that can generate income over time.
