Foreign holdings of EM debt are a key global risk
Subject Risks surrounding increased foreign participation in EM bond markets. Significance The rise in the dollar in anticipation that the Federal Reserve (Fed) will start hiking interest rates next month is putting emerging market (EM) currencies under renewed strain. This stress is testing the resilience of EM bond markets, many of which, such as Malaysia and Indonesia, have high levels of foreign investor participation, or, like China and India, are seeking to attract more. Impacts Monetary policy divergence between the Fed and other leading central banks will put further upward pressure on the dollar. A strengthening dollar will extend oil's 6.6% price drop since November 3, undermining sentiment towards EMs. The composition of foreign holdings (institutional money versus flightier capital) will be key to gauging the vulnerability of EM debt. The largest source of vulnerability in EMs will remain the threat of a harder-than-expected landing for China's economy.