Emerging market debt: Five takeaways for 2025

The investment landscape in 2024 has been largely influenced by idiosyncratic narratives, particularly benefiting distressed issuers and sovereign credits nearing investment-grade status. This trend is expected to persist into 2025, offering discrete spread opportunities for investors, especially in emerging markets (EM). However, the political shift in the US, with Donald Trump's presidency and a Republican-controlled Congress, could have significant implications for EM economies, necessitating a cautious approach to EM foreign exchange (FX) investments.

The outlook for EM high yield remains positive, bolstered by ongoing debt restructuring and reform programs in countries like Sri Lanka, Argentina, and South Africa. Credit ratings upgrades are anticipated to continue, with countries such as Paraguay and Serbia on track for full investment-grade status. Despite concerns about potential downgrades, Mexico is expected to maintain its position due to strong fundamentals like nearshoring and US investments. However, the path to economic stability will vary across the EM spectrum, with challenges in regions like Venezuela and sub-Saharan Africa.

Sovereign default risk in EM is not anticipated in the near term, thanks to robust external funding and innovative debt management strategies like debt-for-nature swaps. As the year progresses, attention may shift to longer-term market access, with legislative elections in key economies influencing reform agendas. Security selection will be crucial for generating alpha, given the increased variability in instruments like state-contingent debt instruments (SCDIs), which offer improved recovery values and liquidity.

Debt relief activism could gain momentum in 2025, a "Jubilee" year, potentially reviving legislative reform efforts. Although previous attempts to reform New York state law governing EM sovereign debt were unsuccessful, further efforts may arise, though they are likely to face strong industry resistance. Meanwhile, the UK government may propose similar initiatives, reflecting its commitment to addressing unsustainable debt.

Finally, the US's protectionist policies could create both opportunities and challenges for EM investments. While some areas of EM debt might suffer, higher-spread hard-currency positions could provide value. However, local-currency bond markets may experience volatility due to anticipated trade tariffs and their inflationary impact, necessitating a cautious investment approach amidst global uncertainties.