Six months have passed since the start of America’s and Israel’s military intervention in Iran and Lebanon. What picture is emerging around the impact of this external shock on the financing conditions of the major emerging economies and on exchange rate movements? And what parallels can be drawn with the 2022 energy shock?
Emerging economies: greater financial resilience to the shock from the Middle East
Financing conditions and exchange rates are holding up better in 2026 than in 2022…
As far as the cost of domestic financing in local currency (by far the main source of government funding) goes, bond yields rose less sharply, particularly for Asian countries, with Türkiye standing as the sole exception (Chart 1)[1]. The main explanation for this is that in 2022, faced with rapidly surging inflation, almost all central banks had raised their key interest rates. Conversely, since February, few have done so, and some have even continued their easing cycles.
However, spreads relative to benchmark yields (US or German) have narrowed for virtually all countries (apart from Türkiye), whereas in 2022, by contrast, these spreads had widened for Central European countries.
This reflects the reaction of the markets, which are just as concerned, if not more so, about the deteriorating public finances in advanced economies as they are about those in emerging economies. In fact, real bond yields[2] in the Asian countries in the sample are currently approximately the same value as at the end of 2019 (before the succession of external shocks that have occurred since the COVID pandemic and the almost universal rise in public debt ratios). By contrast, real bond yields in advanced economies have gone from negative to positive territory.
In terms of the cost of external foreign-currency financing, measured by benchmark bond yields (the basis) plus risk premiums (measured by CDS spreads), the basis has clearly risen as bond yields in advanced economies have normalised since 2022. However, risk premiums have not widened since the end of February, whereas they had tightened for the vast majority of countries in 2022 (Chart 2).
Finally, currencies have depreciated less than in 2022, and most have even appreciated since late spring or early summer last year.
Overall, financing conditions have deteriorated less than in 2022.
…thanks, in particular, to support from non-resident investment in local bond markets
According to the Institute of International Finance (IIF) estimates, non-resident portfolio investment in debt securities and equities in emerging markets has held up better this year than in 2022 (Chart 3), if we exclude China from the sample (due to its dominant weight), as well as South Korea and Taiwan, which are by far the most advanced countries in the IIF sample[3] and have seen massive outflows of investment from equity markets since March[4]. In this adjusted sample, the increased investment in debt securities was significantly greater than in 2022, while trends in equity investment were broadly similar, in line with the smaller widening of bond yields in local currency and the smaller depreciation of currencies.
For the most advanced Asian countries, trade surpluses have offset outflows of non-resident portfolio investment in equities
A comparison of trends in foreign exchange reserves and trade balances – the only data available on balance of payments items other than non-resident portfolio investment for all countries in the sample over the past 5–6 months – provides further insight. Trends in foreign exchange reserves (Chart 4) appear to confirm the view that exchange rates are holding up better[5]. However, trends in trade balances are the same. Nevertheless, for South Korea and, to a lesser extent, Taiwan, the surging trade surpluses (driven by the AI boom in particular) are behind the appreciation of exchange rates over the summer, despite outflows of portfolio investment up until July[6].
