Introduction

Polina Kurdyavko, Head of EM Debt

2025 was a year marked by policy volatility and shifting global narratives, from Trump’s ‘friend or foe’ approach to trade and economic alliances to persistent uncertainty around the Fed’s policy path. Yet, emerging market debt (EMD) demonstrated remarkable resilience, posting double-digit gains across both hard and local currency markets. The hard currency credit index surged by nearly 13%, while local markets delivered returns of approximately 17% year-to-date. This performance was underpinned by high carry, resilient fundamentals, and renewed investor engagement.

As we step into 2026, the global economic landscape presents a constructive yet complex outlook for EMD. Despite a modest slowdown in global growth, EM economies are poised to outpace developed markets (DM), driven by robust domestic demand, policy credibility, and improving fiscal discipline. Inflation in EM remains largely contained, allowing central banks to maintain a measured easing bias. Uncertainty surrounding the US fiscal trajectory and the Fed’s reaction function keeps the dollar’s direction ambiguous, with markets questioning whether this is a cyclical flashpoint or the start of a structural shift towards long-run outperformance – we make the case that it is the latter.

Geopolitics remain front and center with traditional alliances at risk and new strategic relations emerging. Countries are navigating the US-China rivalry, seeking strategic autonomy while benefiting from investment from both powers. In Latin America, elections in Peru, Colombia, and Brazil could bring political shifts, while the region’s minerals attract interest from both the US and China. Sub-Saharan Africa faces challenges, with shifting US policy and the need for more sustainable debt solutions.

In the context of positive technicals, the supply-demand dynamics in EM debt will likely remain robust in the coming year. At the same time, transition financing remains an interesting potential avenue for issuers to bridge financing gaps for economic development and energy security, especially with indications that there is healthy investor appetite for such solutions.

The EM corporate landscape is also evolving, with a rising default environment globally. While headline defaults in EM are expected to rise, the majority are concentrated in a small number of large credits, where stress levels are already well-known and priced in. The EM HY corporate market remains healthy, with robust fundamentals and low leverage levels.

In this year’s EM Debt outlook, we explore these key themes and their implications for investors in the year ahead. We begin by taking a step back to recognize how far EM markets have come – particularly the sustained shift toward monetary orthodoxy and improved policy credibility. As investors continue to champion these developments, it is essential to maintain perspective on both the progress achieved and the inevitable challenges along the way as the asset class continues its journey toward maturity.

Emerging markets - the journey to maturity

Polina Kurdyavko, Head of EM Debt

We recently shared our reflections regarding the successes and challenges within EM countries as their policies and markets continue to evolve. In particular, we highlighted the importance of maintaining perspective as countries deliver on investor ‘wishes’ and remind ourselves that the policies we advocate can also have significant side effects once implemented . There are four key policy themes that are likely to remain in the spotlight across EM in the coming year:

The shift towards monetary orthodoxy

Looking back over the past 25 years, one of the biggest changes in EM has been the widespread adoption of monetary policy orthodoxy, which has enabled countries to have more influence on local inflation dynamics while also developing deep and sophisticated domestic markets. This shift has significantly reduced reliance on external debt, with over 90% of all EMD now issued locally, thereby mitigating vulnerability to external financing shocks.

However, even well-intentioned policies can have unintended consequences. Indeed, in some countries such as Brazil, markets have heralded the commitment of the central bank in maintaining a hawkish stance by hiking rates by 425bps over the past year, resulting in a policy rate of 15%. The orthodox approach has been effective in curbing inflation that has been exacerbated by employment dynamics and fiscal policies. However, it has also rendered corporate borrowing substantially more costly. In Brazil, for example, companies with a leverage level of over 3x now spend 60% of their EBITDA on servicing their interest bills. As a result, local corporate borrowers, some rated investment grade, are seeing their leverage and interest bills nearly double over the last year. This unsustainable position has resulted in a high level of defaults in the local market and, according to Bloomberg, 31% of companies in Brazil (including micro-enterprises) were falling behind on their loan payments as of June 2025.

Across the world, Turkey has also joined Brazil in this double-digit rate environment after hiking rates, from 8.5% in June 2023 to 50% by March 2024. Despite rates cuts this year, with the policy rate at 39.5%, Turkish corporates are still feeling the strain, though many rely more on external rather than domestic funding.

As we discuss later in this report, we expect corporate defaults to rise on the headline level in 2026, although concentrated primarily in certain pockets, such as some portions of the Brazilian market, where paying the price for orthodox monetary policy has crippled balance sheets, and especially in sectors that have also experienced demand slowdown and margin pressure. The silver lining, once again using the example of Brazil, is that most corporates have weathered many crises over the past two decades, fostering resilience. Although default statistics are likely to show an increase, the overall asset quality of EM companies remains strong, presenting opportunities for positive performance for discerning investors. Moreover, we favor opportunities in the local space in markets like Brazil, given attractive real rates and continuous policy orthodoxy.

Beyond Brazil, our outlook for corporate performance is more upbeat in countries like Mexico, Colombia and Argentina. We also think that certain corporates in South Africa and Turkey are well positioned to withstand the current low growth environment. In Asia corporates are benefiting from a low-rate environment given the ongoing disinflationary trend, with most countries having policy rates below that of the US Fed.

Domestic market development and retail participation

EM investors have also looked favorably on efforts by policymakers to develop and deepen their local markets, allowing issuers, sovereign and corporate alike, to refinance their debt domestically and reduce exposure to external volatility. Over the last decade, the local market universe in EM has grown to over USD25 trillion, almost equivalent to the size of US Treasury market, offering funding to corporates, governments, and municipalities. Higher participation of retail investors has contributed to this growth, which would also be viewed by investors as a healthy development.

However, this has also presented new challenges, such as the creation of structured products that have, in some cases, led to excessive leverage and volatility in the system. With the total local corporate market reaching USD12 trillion this year we have seen double digit year-on-year growth in countries like Brazil, Turkey, and Romania, to name a few. In Brazil, the explosive growth in the domestic corporate debt market was fueled by tax incentives for retail investors as well as the creation of structured notes by local brokers (such as COE – Certificadoes de Operacoes Estruturadas in Brazil). The introduction of structured securities has also resulted in certain embedded price triggers that, when activated, can create market volatility.

Recently, excessive volatility has tested these structures, causing forced sales and technical-driven dislocation. In some cases, investment grade corporates have traded at double-digit yields due to these technical factors, rather than fundamental concerns. Additionally, domestic investors often operate in non-regulated segments, which can introduce further leverage and volatility. A recent example is Argentina, where negative provincial election results in Buenos Aires led to sharp swings in bond prices, exacerbated by leveraged domestic positions of local brokers.

As EM investors observing these events, we must also acknowledge that even with the strides being made in local markets, they, too, are susceptible to the speculative bubbles and volatility that we experience in DM and, moreover, that the external markets will not necessarily be immune to these bouts of volatility. This underscores the importance of staying close to local dynamics, even if not investing directly in these markets.

In 2026, we would expect to see further growth in local corporate markets. We would estimate that Asian corporates are likely to dominate issuance in absolute terms, given that China alone accounts for over USD9 trillion in corporate debt outstanding. We would also expect the corporate issuance in this region to be supported by the local reach for yield as central banks are likely to remain on the rate cutting path. We envisage local corporate issuance will remain strong in the Latin American region and a number of frontier markets, as companies focus on local markets as their primary source of funding, supported by a growing domestic investor base.

The path towards FX market liberalization

As part of improved integration with international financial systems, investors have also historically advocated the liberalization of foreign exchange markets. While most major EMs have adopted floating FX regimes and open capital accounts, some are still progressing towards this orthodoxy. In others, such as Argentina, lifting capital controls has proven more challenging, often prompting significant outflows of capital that test the country’s FX reserves, and the prospect that FDI may not return until the new regime has shown it can withstand the test of time and volatility. Needless to say, breaking the cycle is not an easy task. Interestingly, local companies are seeing this as a great opportunity to acquire assets at attractive valuations. Some companies in the electricity and energy sectors have been prudent and have relied in large part on internal cashflow to finance the expansion while keeping leverage low. This can provide interesting opportunities for EM corporate investors to participate in hard currency issuance by these names. That said, local market development in countries undergoing the liberalization of FX and dedollarization will likely face a longer road ahead to building investor confidence.

At the other end of the spectrum, China is cautiously experimenting with capital account liberalization, launching small pilot projects in Shanghai. The memory of nearly USD1 trillion in outflows during the last major attempt in 2015 has made the government wary of nationwide reforms, preferring incremental steps to test the path towards broader liberalization. In this case, we believe tactical local currency exposure could provide an interesting opportunity to benefit from positive sentiment, as the liberalization momentum picks up against a backdrop of a more conciliatory tone between the US and China, albeit in the short term.

In 2026 we will continue to monitor the evolution of the currency liberalization framework in EM with a particular focus on frontier markets. For example, Egypt has reinstated its commitment to transition into a flexible inflation-targeting regime and to allow the exchange rate to be determined by market forces. Other frontier markets like Ghana, Uzbekistan, and Sri Lanka, to name a few, will also be focusing on deepening their domestic markets and targeting a more orthodox FX policy.

IMF policy advice and financial support for HIPC countries

Despite the IMF and World Bank’s initiative to provide financial assistance to Heavily Indebted Poor Countries, or the so-called the HIPC Initiative established in 1996, the majority of these countries are again facing challenges two decades later. Many have participated in numerous IMF programs. However, the combination of demographic pressures, challenges in tax collection, and corruption have increased fiscal burdens and led to restructurings in the last few years in a host of countries, including Ethiopia, Ghana, and Zambia. Some, such as Senegal, still face challenges, struggling to get a staff-level agreement from the IMF that would provide much-needed funding support.

Investors are also demanding a high price for providing liquidity in frontier markets. The Republic of Congo, for instance, recently tested the market with a new bond yielding 13.7% – a clearly unsustainable level longer term, particularly for a country facing high social needs including electricity, water, and health, and an election year ahead of it, while total debt-to-GDP remains at 95% despite a debt restructuring as recently as November 2024. This is in stark contrast to others – like Zambia and Ghana – which have successfully emerged from restructuring and are trading at single-digit yields. We believe investors need to differentiate carefully between countries in this universe and continue to closely monitor steps that they take to emerge on a more sustainable path.

In 2026 we are expecting sovereign defaults to increase from zero this year but to remain below historical long-term average of 1%. With respect to the HIPC countries, we continue to advocate for solutions that provide more sustainable outcomes and a recognition that this will require a more creative approach that could include scope to include private investors. Ideas around this have been raised before, and recent indications from private discussions in IMF circles would suggest an openness to exploring a different approach to supporting these countries. Indeed, 2026 could well be the year that we begin to see traction on such solutions, particularly with more targeted ESG-linked issuance given investors’ focus on transparency of the use of proceeds.

A maturing landscape

EM countries are on their journey to maturity. Over the past two and a half decades, they have evolved significantly, benefiting their economies while also attracting crucial investor participation. Investors who remain flexible and can take a holistic approach to research across the various EM asset classes are likely to be best positioned to distinguish between growing pains and policy failure. This will be key to achieving strong risk-adjusted returns in the coming year.

For our full report, please contact: RBCGAM-USMarketingTeam@rbc.com