Why have rising sovereign bond yields in advanced economies not hit developing economies harder?

When sovereign bond yields, or the interest rates investors demand to hold government debt, rise sharply in advanced economies, many emerging market and developing economies (EMDEs) usually feel the pain — higher borrowing costs, weaker currencies, and capital flowing out. Since the onset of the Middle East conflict, yields in major advanced economies have surged (Figure 1). So why have EMDEs held up well? The answer matters, because it shapes what policymakers in these countries should do next — and how long they have to act. How do rising rates in rich countries reach developing countries? When sovereign bond yields rise in advanced economies, the effects can spread to EMDEs through several channels: • Borrowing costs. Tighter financial conditions globally can raise the cost of borrowing across EMDEs. In addition, the current context of higher energy prices and domestic inflation may push central banks to tighten monetary policy, further raising domestic borrowing costs. • Financial markets. Currencies can weaken, foreign investors can pull money out of local markets, and the cost of funding for banks and companies can rise. • Trade. Rising long-term yields may reflect strong economic activity, elevated inflation expectations, expectations of tighter monetary policy, or concerns about fiscal sustainability in advanced economies. But if higher yields ultimately weigh on growth in those economies, demand for EMDE exports would weaken — adding another layer of economic pressure. In the current episode, exchange rates and portfolio flows weakened earlier in the conflict but have since stabilized (Figure 2). The rise in advanced economy yields has not, so far, triggered a broader or more pronounced deterioration. What does the data show? Recent data are consistent with investors viewing the rise in global yields as an advanced-economy phenomenon, not a sign that EMDE are becoming less creditworthy. Healthy global appetite for higher-yielding assets has also helped support EMDE bonds. Using the U.S. Treasury market as our benchmark, the headline finding is that EMDE dollar-denominated sovereign borrowing costs have risen by less than the increase in the U.S. 10-year yield. This is because dollar-denominated sovereign spreads — the extra interest that developing country governments pay on top of the U.S. Treasury rate — have actually narrowed, partly offsetting the rise in the underlying benchmark. Key findings include: • Between February 27 and September 18, increases in median yields across EMDEs were smaller than the rise in the U.S. Treasury benchmark (Figures 3 and 4). • Median yields for weaker-credit EMDEs stand at around 9 percent, compared with 6.3 percent for stronger-credit EMDEs (Figure 3). • EMDEs with a higher share of short-term debt face median yields of about 7 percent, versus 6.1 percent for those with lower short-term debt (Figure 4). Is the pressure gone? The resilience is real, but so are the risks. Borrowing costs in absolute terms remain high, and two groups of countries face particular pressure. First, economies with weak credit ratings may find it expensive to refinance debt coming due, even without any further widening of spreads. Second, economies with large short-term debt obligations face the same problem — potentially on a tighter timeline, since that debt must be refinanced sooner. A reversal in global risk appetite — or another surge in advanced-economy yields – could quickly make things worse. What should policymakers do? The current period of relative calm is an opportunity that should not be wasted. EMDE policymakers should: • Reduce deficits and stabilize debt. Countries with high debt and limited fiscal space should put in place credible medium-term plans to bring borrowing under control. • Keep inflation in check. Monetary policy should stay focused on keeping inflation under control, especially in countries where rising energy prices are pushing up the cost of living. • Extend debt maturities. Where market conditions allow, governments should lock in longer-term borrowing to avoid being forced to refinance at potentially much higher rates later. • Engage early with official creditors. The most vulnerable economies should work proactively with multilateral institutions to secure concessional financing — loans on favorable terms that are not available in commercial markets — and reduce dependence on volatile market borrowing. The bottom line EMDEs have navigated the surge in advanced-economy yields better than many feared, helped by narrowing spreads and broadly stable global financial conditions. But this resilience is not the same as safety. Borrowing costs remain high; the most vulnerable economies are still under significant pressure, and the external environment could shift quickly. The window for policy action is open — but it will not stay open indefinitely.