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.
