Domestic shifts and geopolitics shape emerging market stability in 2026

Emerging markets enter 2026 on stable footing, yet shifting policies, geopolitical strains and climate risks are reshaping capital flows, technology adoption and the path to resilient, inclusive growth.

Macroeconomic and credit conditions across emerging markets have been resilient this year, and are expected to remain so in 2026. Several interrelated—sometimes unpredictable—developments will influence these conditions, with the potential for pockets of stress.

Geopolitical and policy shifts ripple across EMs. EM governments are focusing on their domestic priorities and also on bolstering cross-border relationships as they seek to navigate tariffs, US-China tensions and other geopolitical stresses. Elections in a number of EMs bring the potential for policy changes. Societal opposition to new and existing policies will continue pushing some EM governments to prioritise social stability over long-term reforms.

Local currency markets and alternative financing vehicles are growing. US policy rate cuts, increased investor risk appetite and a weaker US dollar, along with interest in diversifying away from the US, will continue to spur capital inflows to EMs. This will further the growth of local currency bond markets, which have expanded rapidly over the past decade. Uncertainty in the lead-up to domestic elections and unexpected policy shifts within countries may, however, dampen investor appetite at times, particularly for debt from entities with relatively weak credit quality.

Artificial intelligence (AI) and data centres bring potential for both growth and disruption. Technological advances are likely to exacerbate differences between EMs and advanced economies, and across EMs. Early adopters will benefit as innovation and efficiency boost productivity, investment and corporate earnings, and ultimately support economic growth. But new technology ventures also bring execution, cyber and social risks. Data centre growth will continue in response to AI and cloud computing demand.

Costly natural disasters strain households, businesses and governments. EMs tend to be more exposed to extreme weather events than advanced economies, but have fewer resources for adaptation and resilience. Investment is far below what is needed given competing priorities and financing hurdles. Nearly half of EM sovereigns have high or very high credit exposure to physical climate risks such as floods and hurricanes, but relatively weak fiscal strength, limiting their ability to address these risks.

Credit and macroeconomic conditions will remain largely stable

EM debt issuers are heading into 2026 with solid credit and macroeconomic conditions. Gross domestic product (GDP) growth is broadly steady if subdued, and inflation is easing. Domestic demand for goods and services is robust, trade linkages are diversified, and monetary policy frameworks are credible in many large EMs. Investor demand for EM debt is visible in narrowing credit spreads, bondissuance growth and capital inflows. Corporate and sovereign EM default rates are declining amid these supportive conditions; the corporate default rate will remain near pre-COVID levels over the next 12 months in our baseline projection.

Geopolitical and policy shifts ripple across EMs

Credit conditions in emerging markets will be shaped by a more inward and populist shift in policymaking across major economies, affecting trade and cross-border financial flows. The US-China rivalry adds to policy unpredictability and global fragmentation.

In response to tariffs the US imposed this year, EMs are further diversifying trade relationships. They are negotiating bilateral deals with the US (Aa1 stable), strengthening ties with China (A1 negative), and striking new or updated agreements with the EU (Aaa stable) and other partners. These include the EU's recent trade deal with Indonesia (Baa2 stable), its accelerated free trade talks with India (Baa3 stable), and its negotiations with Thailand (Baa1 negative), Malaysia (A3 stable) and the Philippines (Baa2 stable), as well as the trade agreement between the UK (Aa3 stable) and India.

At the same time, EMs are boosting intraregional trade through initiatives such as the African Continental Free Trade Area and AsiaPacific’s push for deeper integration, which the International Monetary Fund (IMF) has highlighted as critical for economic resilience. Foreign direct investment (FDI) within the Association of Southeast Asian Nations (ASEAN) has increased, according to the latest available data.

On a country level, policy predictability and stability influence FDI. This and political stability are among the factors underpinning consistently strong FDI inflows to Vietnam (Ba2 stable), even through uncertainties related to US trade policy: total registered inward FDI was up 15.6% during the first 10 months of 2025 from the same period in 2024, according to the National Statistics Office of Vietnam. Structural factors such as relatively low production costs, business-friendly policies and a geostrategic location also draw FDI to Vietnam. By contrast, political instability has constrained FDI in Thailand in recent years. In Mexico (Baa2 negative), FDI fell to its second-lowest level ever in the first half of 2025 after a record 2024, as the possibility of sudden changes in US tariffs and the 2026 review of the free trade agreement between the US, Mexico and Canada (Aaa stable) present uncertainty for investors.

EM governments are adjusting domestic policies to preserve their own interests amid the shifting landscape, sometimes in diverging ways. Brazil (Ba1 stable), for example, is leaning into industrial policies and trade protectionism to boost self-sufficiency, while strengthening economic and political ties with China. Mexico, by contrast, is becoming more protectionist toward China while seeking to preserve free trade with the US and Canada.

A number of EM countries will hold elections in 2026 including Peru (Baa1 stable), Colombia (Baa3 stable) and Brazil in Latin America; plus Chile’s (A2 stable) new president will take office in March; Bangladesh (B2 negative) and likely Thailand in Asia; Benin (B1 positive), Ethiopia (Caa3 stable), Uganda (B3 stable) and Zambia (Caa2 positive) in Africa; plus Lebanon (C stable) and Armenia (Ba3 stable), among others. Elections bring the possibility of policy changes in some countries. Preelection uncertainty—over outcomes and potential policy shifts—may reduce capital inflows, spur market volatility and raise fiscal slippage risks. Political polarisation will complicate governments' efforts to address fiscal deficits and high debt burdens.

Social unrest will continue driving governments to prioritise social stability over long-term reforms, while also straining institutional frameworks. Large-scale protests erupted across EMs in 2025, including in Kenya (Caa1 positive), Morocco (Ba1 stable), Peru, Indonesia, Bangladesh and the Philippines. Tanzania’s (B1 stable) post-election protests and government crackdown are among the latest examples of intertwined social and political risks.

Policy unpredictability weighs on corporate and consumer spending. It is also clouding the credit outlook for some EM sovereigns including Poland (A2 negative), Georgia (Ba2 negative), Brazil, Thailand, Colombia, Bangladesh and Indonesia. But the picture is mixed. Various factors are boosting credit quality for other sovereigns, as reflected in recent upgrades for Turkiye (Ba3 stable) Argentina (Caa1 stable), Mongolia (B1 stable), Ghana (Caa1 stable), Costa Rica (Ba2 stable) and Pakistan (Caa1 stable), among others. Against this backdrop, global real GDP growth will likely hover between 2.5% and 2.6% in 2026 and 2027, down from 2.6% in 2025 and 2.9% in 2024. Growth will remain higher for EMs than for advanced economies, with continued differentiation by country

Local currency markets and alternative financing vehicles are growing

Local funding markets have expanded significantly in many of the large EMs in recent years, and this trend is set to continue in 2026. Domestic markets that are deep and diverse increase debt issuers' financing options, reduce their reliance on not-always-accessible cross-border funding, and support financial resilience. By contrast, markets that are shallow and have a narrow investor base carry the risk of sudden capital outflows, thereby triggering market volatility and tightening financing conditions.
As the combination of US policy-rate cuts, improved risk sentiment and a weaker US dollar increase the appeal of EM bonds, capital inflows to EMs are likely to accelerate, supporting further domestic market growth. Inflows have increased in most regions in recent months, particularly into China debt funds. Investors' efforts to diversify away from US assets and US dollar-denominated exposures, prompted by heightened US policy uncertainty and market volatility, could also spur further EM local debt market growth.

In Latin America, large debt issuers in Brazil and Mexico stand out for their ability to tap both onshore and offshore funding. But recent developments in Brazil including a high-profile corporate default and a potential corporate debt restructuring have heightened risk aversion toward the country. This has translated into higher overall spreads for debt issuers, mainly in the offshore market, and may hurt high-yield debt issuers should the situation persist into 2026. In Mexico, the upcoming United States-Mexico-Canada Agreement review expected by mid-2026 is deferring investment and issuance decisions. Debt issuers in Peru are becoming increasingly reliant on cross-border markets because the local currency bond market is contracting due to multiple extraordinary withdrawals from the private pension system since 2020. In 2025, the government approved another round of pension fund withdrawals—the eighth in six years.

In Asia, companies still rely heavily on bank financing, but investment-grade issuers and sovereigns in India, Thailand and Malaysia are active in the liquid local bond markets. In China, onshore issuance growth is driven by government bonds for public projects that support economic growth and consumption. Chinese banks and private companies are also increasing onshore issuance.

Some frontier markets such as Kenya, Nigeria, Uganda and Egypt have made progress in expanding their local currency debt markets. Debt issuers in these markets remain vulnerable to sentiment shifts and capital outflows, however. Other EMs continue to face difficulties from shallow local markets, such as countries in the Central African Economic and Monetary Community (CEMAC). Additionally, elevated interest rates weigh on debt affordability for some sovereigns, such as in Latin America.

For debt issuers that have traditionally borrowed in US dollars for cross-border financing, some are now increasingly choosing to access non-US dollar markets such as the euro, Swiss franc and renminbi to diversify their funding sources and potentially reduce debt costs. Examples include the governments of Egypt (Caa1 positive), Turkiye and Côte d’Ivoire (Ba2 stable), along with some governments in Latin America.

Additionally, some governments in Sub-Saharan Africa are turning to alternative sources when available, such as private placements, bank loans and secured borrowing, as eurobond access tightens. Similarly, in the Commonwealth of Independent States (CIS), banks are increasingly turning to international capital markets for longer-term funding, given the short-term nature of local banking funding.

Alternative financing is also on the rise

Private credit is growing but still nascent in EMs. It is gaining traction as an alternative funding source in Latin America and will also play a role in Saudi Arabia's (Aa3 stable) efforts to diversify its economy beyond oil.

Additionally, digital finance including digital cash and digital currency is expanding, improving access and efficiency, but its impact varies by region. For African banks, for example, growing use of digital payments and the wide variety of digital payment channels will bolster business growth and profit generation.

EMs are becoming testing grounds for new credit architectures. In regions where conventional financial infrastructure remains underdeveloped, digitalisation enables a leapfrog effect. AI could be an accelerator of financial inclusion where traditional mechanisms have historically failed. The growing use of stablecoins and central-bank digital currencies (CBDCs) is helping to mitigate currency volatility and transaction friction. Tokenisation facilitates microfinance.

AI and data centres bring both growth and potential disruption

Technological advances are likely to exacerbate differences between EMs and advanced economies, and across EMs. Early adopters will benefit as innovation and efficiency boost productivity, investment and corporate earnings, and ultimately support economic growth. AI, for example, has the potential to help governments improve controls and revenue collection. Albania (Ba3 stable), Jordan (Ba3 stable) and Brazil are using it to this effect. But new technology ventures also bring execution, cyber and social risks.

The latter come from the potential for technology, particularly AI, to replace jobs, including at call centres in EMs. For the next two to three years, however, AI is likely to support employees rather than replace them fully. Companies are investing in developing employees as they move toward AI-led offerings, which is helping to reduce job losses. There is limited evidence of AI disruption to large call centre outsourcing companies' earnings to date. But companies with limited financial resources, including among IT outsourcing companies, may find it difficult to make the continuous investment needed to keep up with competitors as technology advances.

China is the technological leader in EMs. Chinese technology companies are increasing their investments in AI and cloud computing, boosting demand for data centres to meet future computing needs. The country's technology sector benefits from policy support as the Chinese government continues its efforts to move the country's economy up the value chain to increase economic competitiveness, productivity and living standards. The emergence of cost-efficient large language models since early 2025 accelerated this trend, by making AI more accessible to a broader range of companies, including smaller internet startups that previously lacked the resources to implement cutting-edge technologies.

This accelerating adoption of AI aligns with the Chinese government’s policy agenda, which emphasises technology upgrades as a key strategy for achieving higher-quality economic growth over the next five years, supporting the continuous growth in AI applications. Some leading internet service companies in China have leveraged these advancements to achieve solid revenue growth alongside improved operational efficiency, even as overall consumer spending in the country remains subdued.

China also has a dominant role in rare earths supplies used to produce AI chips, data centre cooling systems and fiber optic transmission systems. This allows China to influence global supply chains and prices, making the country a critical component of the AI and tech industries and creating risk for companies that rely on Chinese supply. The country's October announcement—and then suspension—of more stringent controls on rare earth elements is the latest example of its influence, and of the unpredictability of geopolitical developments.

Geopolitics—mainly US-China tensions and data localisation—are shifting data centre growth from China to other Asia Pacific EMs. Malaysia, Indonesia, Thailand will be key beneficiaries as US, Chinese and local data centre operators expand into these countries. Malaysia and Indonesia have also been direct beneficiaries of spillover demand from Singapore because of the latter's energy sourcing and efficiency requirements, and land availability limitations.

Latin America remains attractive to data centre developers because of its abundant renewable energy and increasingly favourable investment frameworks. Brazil has the most capacity in the region, supported by a large digital economy and competitive power prices. Mexico, the second-largest market, benefits from proximity to the US, special economic zones and a surge of hyperscale investments in the central state of Querétaro. Chile, third in line, has a business-friendly environment, clean energy access and national plans to expand digital infrastructure. Argentina, though nascent, is attracting initiatives such as OpenAI’s proposed AI hub in Patagonia. Water stress and regulatory volatility remain key risks, however.

Saudi Arabia and the United Arab Emirates (Aa2 stable) have unveiled ambitious national strategies to become AI leaders. The countries are investing heavily in data centre build-out, including cloud computing and AI infrastructure, thereby positioning themselves as key nodes in global supply chains. But talent, infrastructure and regulatory readiness remain pain points and an innovative startup culture is only slowly emerging.

Costly natural disasters strain households, businesses and governments

Emerging markets tend to have greater credit exposure to extreme weather events than advanced economies but fewer resources for adaptation and resilience. Investment is far below what is needed because of competing priorities and financing hurdles. Yet the economic and insurance losses from climate events are significant, as illustrated most recently by the damage in Jamaica (B1 positive) from Hurricane Melissa. Adaptation is a central theme of the 2025 UN Climate Change Conference (COP30), which runs through 21 November.

Sovereigns and regional and local governments in EMs have high inherent exposure to physical climate risks such as floods and hurricanes, according to our environmental risk heat map. On an individual country level, nearly half of more than 100 EM sovereigns have high or very high credit exposure to physical climate risks, as reflected in their issuer category scores. Many of these sovereigns also have comparatively weak fiscal strength, which limits their ability to address these risks.

Other entities within these countries are also exposed to physical climate risks. In Latin America, for example, at least half of the debt issuers we rate in Brazil, Chile, Colombia and Mexico have moderate or high credit exposure to these risks. Exposure is highest for sectors with fixed operating assets such as agriculture, mining, utilities and infrastructure.

Financial institutions are indirectly exposed through their lending and investment portfolios. For example, African banks, particularly in East Africa, are exposed through loans to the agriculture sector. The banks' loan-book diversification is a mitigant, however.

Physical climate risks exacerbate related social risks by, for example, displacing people physically, disrupting access to basic services such as water and power, and threatening health and safety.

Water is a key credit transmission channel for physical climate risks. In water-intensive sectors, water scarcity, flooding or degradation of water quality can abruptly reduce revenue, raise operational costs and force large capital outlays for adaptation. Effective water management practices can be a key mitigant to such risks. However, inherent exposure to water management risk is high for EM regional and local governments and moderate for EM sovereigns, according to our heat map. The individual sovereigns with high water management risk exposure are also mostly EMs in Sub-Saharan Africa and Asia Pacific.

Governments typically fund adaptation, but few in EMs have fully costed plans, and climate budgeting remains nascent. International public adaptation finance flows to developing countries were $26 billion in 2023, down from $28 billion in 2022 and far below the $310 billion to $365 billion needed per year by 2035, according to the United Nations Environment Programme (UNEP).

Multilateral development banks will continue to channel resources toward climate-related projects to help meet EMs’ large financing needs. But other sources such as blended finance and philanthropy capital are also needed to fill the large financing gap. As regards financing instruments, tailored instruments like climate-resilient debt clauses, debt-for-nature swaps and sustainable bonds offer various options to focus financing on climate investment and strategy.

A Moody's Ratings report re-disseminated by Wealth and Society