Reassessing Risk in Emerging Market Lending: Insights from GEMs Consortium Statistics

Emerging markets have long been viewed as high-risk destinations for investment, particularly investments in companies.  Although macroeconomic and political stability risks are higher, this perception also reflects project-level risks, or uncertainty about repayment prospects. Investors, with limited historical data and a lack of reliable metrics on the likelihood of default and recovery rates, approach emerging markets with great caution.

Our research challenges this view. Newly released statistics from the Global Emerging Markets Risk Database (GEMs), a consortium of 26 multilateral development banks (MDBs) and development finance institutions (DFIs) pooling their credit risk data, provides a way to analyze the risks in a more nuanced way. The statistics offer insights into default and recovery patterns for loans to emerging market firms over the past three decades, especially when investments are made alongside MDBs and DFIs. They also highlight the benefits of incorporating emerging market exposure into diversified investment portfolios.

Data Coverage and Scope 

The GEMs credit risk statistics for private lending, published in October 2024, are among the most comprehensive of their kind. Spanning the period 1994–2023, the data include about 15,000 loans extended to approximately 10,000 private counterparties across essentially all emerging and developing economies. The total value of these loans exceeds half a trillion dollars. This coverage captures nearly 2,000 default events, providing a robust foundation for analyzing default and recovery rates. Comprised of loans issued by MDBs and DFIs, the GEMs data span all sectors of the economy, including transportation and energy infrastructure, manufacturing, agribusiness, financial services, telecom, retail and wholesale, healthcare, and tourism. They differ from a typical purely commercial portfolio, however, in that MDBs and DFIs often provide advisory support for project development and implementation by local in-country teams.

Default Rates: How Risky Are Emerging Markets?

Default rates are a guiding metric for investors, as they indicate the frequency with which borrowers fail to meet their financial obligations. Between 1994 and 2023, the average default rate in the GEMs portfolio was 3.6 percent. This is roughly comparable to average default rates observed in non-investment grade companies that receive a B credit rating from S&P (3.3 percent) and a B3 from Moody’s (4 percent). The comparator group of corporates rated by S&P and Moody’s covers firms across the globe, with heavy representation of advanced economies, whereas the sample covered by GEMs consists primarily of firms in emerging and developing economies.  But the takeaway is clear: although emerging market corporates, on average, are not investment grade, they are lower risk than many high-yield corporate borrowers from advanced economies.

One of the key insights from the GEMs data is the diversification benefit of holding a portfolio that includes both advanced and emerging market assets. Default rates in GEMs portfolios are correlated with those of advanced economies, but the correlation is far from perfect. The correlation coefficient between GEMs default rates and those for S&P B-rated firms is 0.46, whereas the correlation for Moody’s B3-rated firms is 0.33. This relatively low correlation indicates that emerging market defaults do not necessarily follow the same patterns as those in advanced economies, particularly during times of economic stress.

Figure 1 shows that investors with exposure to both advanced and emerging market assets can mitigate some of the risks associated with economic downturns in advanced economies. For example, during the 2008 global financial crisis, which originated in the advanced economies, defaults by emerging market firms were less pronounced than among their advanced economy counterparts. This suggests that advanced economy investors with portfolios including emerging markets reaped diversification benefits at a crucial time.

Country Patterns: Does Income Level Matter?

The GEMs statistics reveal interesting patterns when viewed by country income level. As expected, default rates are negatively correlated with income level. But the gap between advanced and lower-income economies is not as pronounced as one might expect (Figure 2).

In high-income economies, the average GEMs default rate was 2.3 percent—slightly higher than the country credit rating (Figure 2). The default rate on private borrowers in the GEMs statistics increases as income level declines, reaching 6.3 percent in low-income countries. But except for high-income countries, the default rate in the GEMs sample was lower than would be expected based on the corresponding countries’ sovereign risk ratings. Comparing the default rates in the GEMs sample to those implied by the sovereign ratings, one can observe a small difference of -0.6 percentage points for advanced economies but a larger gap of 7.9 percentage points for low-income countries.

This finding challenges the conventional wisdom that investments in corporations or private sector projects in low-income countries are excessively risky, possibly due to factors unrelated to business performance, such as political instability or currency volatility. In practice, the GEMs statistics show that the risk is much lower than based on sovereign credit ratings. This may be because the GEMs data include loans from DFIs and MDBs, which may be able to mitigate some of these risks through a combination of local expertise, in-country staff, advisory services, and active supervision during project implementation. Relying solely on sovereign ratings in this context would lead investors to overstate the risks of lending to firms in these markets.

 Recovery Rates: What Happens After Default?

The GEMs statistics also reveal that recovery rates, which measure the amount of investment recovered after a default occurs, were higher than expected. On average, 72 percent of the value of defaulted GEMs consortium loans were recovered, compared to 70 percent reported for Moody’s Global Loans, 59 percent at Moody’s Global Bonds, and 38 percent at JPMorgan Emerging Market Bonds.

These relatively high recovery rates suggest that even in cases where defaults occur, investors in emerging markets are likely to recoup a significant portion of their investments. This relatively strong GEMs performance may be a result of MDBs and DFIs having a deeper understanding of local markets and stronger relationships with borrowers.

Conclusion: A Reassessment of Risk

These results suggest that investing in firms located in emerging markets is not as risky as might have been expected. GEMs statistics reflect the unique experience of multilateral development banks and development finance institutions, including more in-country staff than global commercial investors and detailed knowledge of the regulatory and political aspects of the market. Notwithstanding those caveats, the results presented in this note provide general encouragement for investors potentially interested in investing—directly or alongside GEM participants—in emerging market businesses.