In the global economy, credit risk varies significantly between emerging and developed markets. This study reveals that while emerging markets are often perceived as riskier, their sector-specific risks sometimes rival or even outperform those in developed economies. Key findings include:
- Default Rates: Emerging markets have an average default rate of 3.6%, comparable to non-investment-grade companies in developed markets.
- Recovery Rates: Recovery rates in emerging markets average 72%, higher than many developed market instruments.
- Sectoral Differences: Developed markets face increased risks in consumer-driven sectors, while emerging markets show resilience in tradable industries.
- Economic Factors: Political instability, currency volatility, and regulatory environments drive credit risk disparities.
The study emphasizes that businesses must assess risks at both sectoral and regional levels, leveraging tailored strategies like accounts receivable insurance, credit monitoring, and diversification to navigate these challenges effectively.
Credit insurance helps financial institutions reduce risk in emerging market investments
Study Methods and Data
This research dives deep into sectoral credit risk, leveraging a wealth of data and a variety of analytical approaches. By examining decades of financial information from both emerging and developed markets, the study provides a comprehensive look at credit risks across different regions and industries.
Data Sources and Regions Analyzed
One of the primary resources for this study is the Global Emerging Markets Risk Database (GEMs) Consortium, which aggregates data from 26 multilateral development banks and financial institutions. This database covers the period from 1994 to 2023 and includes around 15,000 loans made to 10,000 private entities in emerging and developing economies. With over $500 billion in loans and nearly 2,000 recorded defaults, the GEMs database offers a solid foundation for understanding credit risk trends.
Another segment of the research focused on 350 firms across 23 emerging markets during three key timeframes: 2002–2006 (pre-Global Financial Crisis), 2007–2009 (Global Financial Crisis), and 2010–2015 (post-Global Financial Crisis). This analysis relied on firm-level credit risk and financial data from the Markit database and Datastream. The list of emerging markets was based on classifications from the International Monetary Fund (IMF) and Morgan Stanley Capital International (MSCI).
The GEMs database spans a broad range of sectors, including transportation, energy infrastructure, manufacturing, agribusiness, financial services, telecommunications, retail, healthcare, and tourism. This wide coverage allows for a detailed examination of industry-specific risk patterns across various market types.
The post-Global Financial Crisis period (2010–2015) is particularly noteworthy, as corporate borrowing in emerging markets surged by 43% between 2007 and 2015. This stands in stark contrast to developed economies, where companies focused on reducing debt during the same period.
Risk Metrics Used
The study applied a variety of metrics to evaluate sectoral credit risk, starting with the 5 Cs of Credit: Character, Capacity, Capital, Collateral, and Conditions. These principles guided the analysis, using data from major credit bureaus like D&B, Experian, and Equifax.
Key metrics from the GEMs database included default rates and recovery rates. Between 1994 and 2023, the average default rate for GEMs loans was 3.6%, while 72% of the value of defaulted loans was recovered on average. These benchmarks provide a basis for comparing sectoral performance across different markets.
To assess real-time credit risk, researchers used credit default swap (CDS) spreads, which reflect market perceptions of default probabilities. Forward-looking credit metrics, such as loan policy exceptions, underwriting trends, loan grade migrations, and concentration risks, were also analyzed. Additional measures included loan-to-value ratios, debt service coverage ratios, credit bureau scores, and debt-to-income ratios.
Capital data was sourced from public financial statements, while macroeconomic factors were evaluated by examining each country’s geopolitical and economic conditions, as well as industry-specific trends. This layered analysis helped differentiate risks tied to individual companies from those arising from broader sectoral or regional dynamics.
The GEMs dataset stands apart from typical commercial portfolios due to the involvement of multilateral development banks and development finance institutions, which often provide advisory support through local teams. This added layer of support required researchers to adjust their models to account for its impact on default and recovery outcomes.
These meticulous methods form the backbone of the study, setting the stage for a detailed comparison of sectoral credit risks between emerging and developed markets.
Credit Risk Comparison: Emerging vs. Developed Markets
When comparing credit risks across sectors, the data reveals some surprising insights about emerging and developed markets. Contrary to common belief, emerging markets aren’t always the riskier option. In fact, sector-specific credit risks differ significantly between the two, challenging the traditional notion that emerging markets inherently carry higher investment risks.
Risk Levels by Sector
The Global Emerging Markets Risk Database (GEMs) highlights an interesting trend: corporate borrowers in emerging markets often present lower risks than many high-yield corporate borrowers in developed economies. Between 1994 and 2023, the average default rate for emerging markets stood at 3.6%.
Default rates, however, vary depending on income levels. High-income economies reported an average default rate of 2.3%, while lower-income countries saw a higher rate of 6.3%. In the U.S., consumer-driven sectors like Commercial Real Estate (CRE), Agriculture, and Oil & Gas are particularly vulnerable to credit risk.
Banking sector data further reveals that loans to households and non-tradable sectors are more likely to contribute to system-wide financial distress. On the other hand, credit extended to corporations in tradable industries shows a stabilizing effect on systemic banking behavior. Agriculture, in particular, illustrates how regional factors influence risk, with marked differences between regions.
These patterns point to the importance of understanding the economic and political contexts that drive these variations in risk.
What Causes Risk Differences
The differences in credit risk stem from a mix of economic, political, and currency factors. While default rates tend to decrease as income levels rise, the gap between advanced and lower-income economies isn’t as wide as one might expect.
Political and economic stability play a major role. Emerging markets often deal with challenges like weaker political institutions, corruption, and less stable governments. However, developed markets are not immune to such issues, as political uncertainties have been increasing in recent years. Additionally, currency fluctuations and varying macroeconomic policies further shape risk profiles. For example, in emerging economies, systemic risks in banking are often linked to household credit growth and tradable sector lending. In contrast, advanced economies face systemic fragility from credit extended to non-tradable sectors.
Interestingly, while default rates in emerging markets correlate with those in developed markets, the relationship isn’t perfect. For instance, the correlation coefficient between GEMs default rates and S&P B-rated firms is 0.46, and with Moody’s B3-rated firms, it’s 0.33. What’s more, emerging markets often demonstrate resilience through higher recovery rates. The average recovery rate in emerging markets is 72%, surpassing recovery rates for instruments like Moody’s Global Loans (70%), Moody’s Global Bonds (59%), and JPMorgan Emerging Market Bonds (38%).
Sectoral Risk Comparison Table
| Risk Factor | Emerging Markets | Developed Markets | Key Difference |
|---|---|---|---|
| Average Default Rate | 3.6% (1994–2023) | 3.3% (S&P B-rated) | Comparable default rates |
| High-Income Economy Default Rate | 2.3% | N/A | Lower risk in wealthier economies |
| Low-Income Economy Default Rate | 6.3% | N/A | Higher risk in lower-income regions |
| Average Recovery Rate | 72% | 59–70% (varies by instrument) | Higher recovery rates in emerging markets |
| Political Risk Impact | Established risk premium | Growing political uncertainty | Developed markets face rising risks |
| Banking Sector Systemic Risk | Linked to household credit growth | Tied to non-tradable sector lending | Different systemic risk drivers |
| Consumer-Driven Sectors | Varies with income levels | Most vulnerable to credit risk | U.S. consumer sectors are especially sensitive |
This data paints a more nuanced picture of investment risks in emerging markets. While challenges like political instability and lower income levels remain, these markets often exhibit resilience, particularly through higher recovery rates and sector-specific strengths. Meanwhile, developed markets are grappling with evolving risks, such as political uncertainty and vulnerabilities in consumer-driven sectors. These insights are crucial for businesses navigating cross-border trade and investment opportunities.
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Factors That Drive Sectoral Credit Risk
Sectoral credit risk is influenced by a web of interconnected forces. These factors operate on multiple levels – ranging from macroeconomic policies and currency shifts to global market trends – and interact in ways that can either amplify or mitigate risks across various industries and regions.
Economic and Policy Factors
Key economic indicators like interest rates, inflation, and GDP growth heavily influence credit risk. However, their effects differ significantly between emerging and developed markets. For instance, while emerging markets often experience faster GDP growth, this growth tends to come with higher volatility.
Government fiscal and monetary policies are equally impactful. In emerging economies, sudden policy changes – such as shifts in government spending or regulatory adjustments – can quickly alter the risk landscape of entire industries.
Inflation adds another layer of complexity. Developed markets generally enjoy more stable inflation levels, while emerging markets frequently face unpredictable price swings. This disparity can unevenly affect sectors. For example, manufacturing companies tied to long-term contracts may struggle to adapt to inflationary pressures, whereas service providers can often adjust their pricing more easily.
Stronger regulatory systems in developed markets generally help lower credit risk. However, even in these regions, evolving regulatory requirements can introduce fresh challenges.
These macroeconomic elements lay the groundwork for vulnerabilities that are further influenced by currency fluctuations and political uncertainties.
Currency Changes and Political Risk
Currency volatility is a major concern for businesses operating across borders. For instance, emerging market currencies have weakened by an average of 4% against the US dollar this year alone. Over the past two decades, some high-risk emerging market currencies have depreciated by as much as 80%, driving up the cost of servicing debt.
Political instability compounds these risks. Brazil’s political upheaval during 2015–2016, marked by scandals and the impeachment of President Dilma Rousseff, triggered an economic crisis and a severe recession. This serves as a clear example of how political events can sharply elevate credit risk.
While interest rate differences between nations play a role in currency movements, studies suggest that political developments and global risk sentiment often have a greater impact. Events like the Brexit vote in 2016 and the US–China trade tensions illustrate how political uncertainty can drive significant currency fluctuations.
These currency and political risks don’t operate in isolation – they interact with local market conditions, creating a more complex risk environment.
Global vs. Local Market Effects
Global economic trends often ripple through specific sectors. For example, export-driven manufacturing industries are highly sensitive to global slowdowns, while domestic service sectors tend to remain more stable.
The banking sector offers a good case study of how global and local factors intertwine. Research shows that a 1% improvement in banking stability correlates with a 3.895% increase in economic growth. However, the drivers of stability differ by region: emerging markets often face challenges like rapid credit expansion and currency mismatches, while developed economies deal with issues like regulatory compliance and market saturation.
The rise of populism and nationalism has also disrupted global trade relations, affecting currency markets and reducing investor confidence in certain currencies. Additionally, liquidity challenges mean that emerging markets often face higher transaction costs and greater price volatility compared to developed economies.
Global financing gaps further exacerbate local credit risks. For example, official development assistance dropped by more than 7% between 2023 and 2024. Emerging markets (excluding China) face a staggering cumulative investment gap of over $10 trillion by 2050 to meet net-zero transition goals. Countries that have experienced the sharpest narrowing of interest rate differentials with the US have also seen the largest currency depreciations, underscoring how global monetary policies can ripple through local economies.
Understanding these interconnected factors is crucial for crafting effective risk management strategies tailored to specific sectors and regions.
Business Impact and Risk Management Options
As businesses navigate the challenges posed by sectoral credit risks, the need for practical strategies becomes evident. These risks affect companies across both emerging and developed markets, making it crucial to maintain profitability and seize growth opportunities despite uncertainties.
Impact on Cross-Regional Trade
Unpredictable trade conditions and economic uncertainty are taking a toll on emerging markets, slowing their growth and increasing currency volatility. These disruptions don’t just stop at the borders – they ripple across sectors, influencing global economic trends, investor sentiment, and trade relationships.
For U.S. companies reliant on exports, challenges like tariff-driven slowdowns, falling commodity prices, and fluctuating currencies have created a tough environment. Meanwhile, Asian nations with strong export ties to the U.S. and supply chain connections to China are experiencing even greater disruptions.
Adding to these challenges are financing gaps, particularly for micro, small, and medium enterprises (MSMEs), which make up 90% of businesses. Since 2021, monthly capital flows to emerging markets have been highly unpredictable, with debt and equity investments swinging dramatically. This volatility forces businesses to either hold larger cash reserves or turn to alternative financing, complicating long-term planning.
The scale of these risks is staggering. Many emerging and developing economies face a high risk of default, with corporate bond debt now 8.5 times higher than in 2008. Sovereign bond debt has also surged, reaching nearly $12 trillion in 2024 – an increase from under $4 trillion in 2008. These numbers underscore the pressing need for effective risk management tools.
How Accounts Receivable Insurance Helps
Accounts receivable insurance offers a powerful solution for mitigating these risks. Since accounts receivable often represent about 40% of a company’s assets, protecting this critical portion of the balance sheet becomes essential, especially in volatile markets.
This type of insurance safeguards businesses against non-payment of commercial debts, whether due to customer bankruptcy or prolonged defaults. It’s particularly valuable when working with clients in emerging markets, where weaker governance and political instability can quickly turn reliable customers into financial liabilities.
Mike Libasci, President of International Fleet Sales, shares how this insurance has transformed his business:
"Accounts receivable insurance has allowed us to take on customers and transactions we wouldn’t have felt comfortable taking on by ourselves… It has not only allowed my company to take on larger deals, but be more liberal in terms, and the result has gone straight to our bottom line."
Beyond protection, accounts receivable insurance also provides a competitive edge. Ori Ben-Amotz, CFO at Hadco, explains:
"With accounts receivable insurance, we don’t have to ask for cash up front or payment on delivery, which makes us much more competitive. This is the tool we needed to take more market share from our competitors."
The cost of this insurance is relatively low – typically a fraction of one percent of sales. Policies generally cover 80% to 100% of the debt amount, offering peace of mind while enabling companies to extend better credit terms and expand sales. Additionally, insured receivables are viewed as lower-risk assets by lenders, which can improve borrowing terms.
Risk Management Strategy Comparison
Managing sectoral credit risks requires a mix of strategies. Each approach has its strengths and limitations, and their effectiveness often depends on the specific market conditions.
| Risk Management Options | Advantages | Limitations |
|---|---|---|
| Accounts Receivable Insurance | Protects against non-payment, enables sales growth, improves financing terms | Premiums impact profitability, coverage gaps may exist |
| Risk-Based Pricing | Higher interest rates compensate for riskier borrowers | May deter some borrowers, reducing market opportunities |
| Loan Portfolio Diversification | Reduces exposure to specific sectors or regions | Requires expertise in multiple sectors, limiting specialization |
| Regular Credit Monitoring | Identifies early warning signs of financial distress | Requires ongoing effort and may not prevent sudden defaults |
| Effective Loan Underwriting | Ensures loan terms suit borrower’s financial situation | Slows business development due to thorough due diligence |
| Loan Loss Reserves | Provides a financial cushion for unexpected losses | Ties up capital that could be used for growth |
| Collateral Requirements | Minimizes risks for lenders | Limits borrowers without acceptable collateral |
The best results often come from combining these strategies. Cathy Jimenez, Credit Manager at Del Campo, highlights the value of accounts receivable insurance:
"I tell them there is a cost, but it’s easily offset by what you get. When you think about the benefits and what you could lose if a customer went bankrupt or just failed to pay, the cost of credit insurance balances out. I strongly recommend it."
Pairing accounts receivable insurance with automation tools can further strengthen risk management. Companies using accounts receivable automation have reported a 66% improvement in Days Sales Outstanding (DSO) and a 49% reduction in delinquency rates. Together, these tools create a system that not only protects against losses but also optimizes cash flow.
For businesses facing diverse risks across markets, accounts receivable insurance offers flexibility. Coverage options include whole turnover, key accounts, single buyer, or transactional risks. This adaptability allows businesses to tailor their approach, whether they’re dealing with the high volatility of emerging markets or the more stable but still uncertain conditions in developed economies.
Key Takeaways for Businesses
The study highlights how nuanced risk profiles call for tailored management approaches. By grasping these findings, businesses can make smarter choices about investments, asset protection, and strategies that yield optimal results.
Main Study Findings
The data reveals three important patterns:
- Emerging markets show a default rate of 3.6%, similar to non-investment grade companies, with an average recovery rate of 72%. Private borrowers in lower-income countries had a 6% default rate, significantly lower than the 14% suggested by sovereign ratings.
- Default rates in emerging markets align with those in advanced economies but are less severe during downturns. For instance, during the 2008 global financial crisis, emerging market firms experienced smaller increases in default rates compared to similarly rated companies in developed nations.
- Sectoral risks vary widely between market types. Export-driven companies in emerging markets are more exposed to tariff and trade risks, while banks in these regions face heightened borrower risks and market volatility. Additionally, market concentrations differ notably between emerging and developed economies.
These insights provide a foundation for crafting effective risk management strategies.
Next Steps for Risk Management
To address these findings, businesses should consider the following strategies:
- Expand risk assessments beyond sovereign ratings. Focus on the fundamentals of individual companies and sector-specific factors. Sole reliance on sovereign ratings can misrepresent corporate risks in emerging markets.
- Diversify investments. Spreading investments across various regions and sectors can significantly reduce overall portfolio risk.
- Leverage technology for continuous monitoring. Implementing tools like accounts receivable automation has shown to improve Days Sales Outstanding by 66% and reduce delinquency rates by 49%. This enables businesses to respond proactively to market changes.
- Protect assets with accounts receivable insurance. Accounts receivable often make up 40% of a company’s assets. Safeguarding this critical component is vital, especially when entering high-risk sectors or regions. The U.S. trade credit insurance market, valued at $2.02 billion in 2023, is projected to grow at an annual rate of 10.6% through 2030.
- Tailor strategies for specific markets. Develop focused plans to reduce exposure to tariffs and trade uncertainties, particularly for export-driven sectors in emerging markets.
- Forge strategic partnerships. Collaborate with trusted partners to share risks and gain insights from local market expertise.
The study underscores that informed, targeted risk management is far more effective than simply avoiding risk altogether. By understanding the unique challenges of different sectors and implementing protective measures, businesses can seize growth opportunities while maintaining financial stability.
FAQs
How do recovery rates differ between emerging and developed markets, and what drives these differences?
Recovery rates in emerging markets average about 72%, typically outpacing those in developed markets. This gap is often due to factors like stronger support from multilateral organizations in emerging economies and better recoveries after defaults. On the other hand, developed markets tend to see lower recovery rates, influenced by differing macroeconomic conditions and more intricate financial systems.
For businesses with global operations, understanding these differences is essential. It underscores the need to carefully evaluate credit risk profiles across regions. To navigate these challenges, tools like accounts receivable insurance can offer valuable protection, helping to mitigate risks tied to non-payment or economic uncertainty in both domestic and international markets.
What key economic and political factors contribute to differences in credit risk between emerging and developed markets?
Emerging markets face several economic hurdles that contribute to higher credit risks. Macroeconomic instability, lower sovereign credit ratings, and exposure to climate-related financial risks are key factors. These challenges often result in steeper borrowing costs for businesses in these regions.
On the political front, issues like political instability, governance problems, and societal unrest are more common in emerging markets. Such conditions create a less predictable environment and raise the chances of credit disruptions, contrasting with the generally steadier landscapes of developed markets. Together, these economic and political dynamics significantly influence the credit risk profiles of businesses operating in these areas.
What strategies can businesses use to manage credit risks in both emerging and developed markets?
To navigate credit risks effectively in both emerging and developed markets, businesses should prioritize diversifying their portfolios and adopting proactive risk management strategies. Customizing risk models to reflect the specific economic and credit conditions of each market is a key step in this process.
Keeping a close eye on macroeconomic trends and political developments is equally important, as it allows businesses to foresee potential challenges. By tapping into local expertise and insights, companies can gain a deeper understanding of market-specific issues, leading to smarter decisions and stronger measures to mitigate risks.
