What do tariffs mean for emerging market debt?

Kirstie Spence

April 10, 2025

How EMs will be impacted by the tariffs

First order impact

At this point, it is challenging to determine the precise impact of tariffs on EM economic activity as there are too many moving parts, including the possibility of negotiated reductions, retaliatory actions by US trading partners, and fluctuations in the currencies of affected economies. That said, we can look at the current level of tariffs and exports to the US to give us an idea about the portion of EM GDP that is at risk (see chart below). Economic theory suggests that tariffs should lead to weaker exports and reduce domestic inflation in the tradable goods sector.

Based on current level of tariffs (as of 8 April), Asia will bear the brunt, with Latin America coming off better. Elsewhere, Central & Eastern Europe (CEE) countries have limited trade with the US, so any direct impact will be relatively muted. Most Middle Eastern countries are only facing the baseline tariffs, while energy might be excluded. Africa is a mixed bag, with some markets at or close to the baseline and others more significant.

There is also a more indirect impact that will be felt by countries that are more trade-oriented and integrated in global supply chains. Tariffs will result in a drag to the overall trade cycle, reducing overall exports and growth. Asia, again, will be in the firing line, given their trade links with China, but also Central and Eastern Europe and Türkiye given their links to the EU.

Direct impact from tariffs on EM countries

Tariff rate and exports to the US

Source: DataStream and White House. As at 7 April 2025. THB = Thailand, MYR = Malaysia, DOP = Dominican Republic, HUF = Hungary, CLP = Chile, COP = Colombia, ILS = Israel, PHP = Philippines, NGN = Nigeria, CNY = China, ZAR = South Africa, INR = India, IDR = Indonesia, PLN = Poland, BRL = Brazil, SAR = Saudi Arabia, RON = Romania, TRY = Türkiye.

Secondary effects:

These are likely to dominate EM through the following channels:

Slower US growth, but possible upside from China stimulus. Higher US import prices will negatively impact domestic consumers, while the uncertainty around tariffs might cause businesses to postpone investment and hiring. Slower US/global growth (and potentially a recession) has the potential to impact EM countries through weaker demand for exports, lower tourism and remittances. That said, a significant stimulus package from China, if it materialises, could offset some of the weakness in US growth.

Oil prices have dropped, which will affect EM countries differently. Saudi Arabia is the most exposed among GCC economies, while the UAE remains the most diversiﬁed. Meanwhile, lower oil prices will be a significant positive for the big energy importers like India and Türkiye, where the benefits of lower oil prices could outweigh the negative impact of slower US growth.

Lower EM inflation looks likely. Unlike the US, which is facing higher inflation risks, tariffs might heighten deflationary pressure in China, which may then spill over to the rest of EM. With Chinese exporters increasingly excluded from the US market, Chinese goods might be redirected to other countries, thereby lowering prices in those economies. Weaker global growth and lower commodity prices may also lead to lower EM inflation.

Market sentiment currently weak, but core EM should be resilient. The last few years have seen a bifurcated EM universe emerge, consisting of higher-rated core EM countries and lower-rated frontier economies. Lower-rated economies may struggle with a prolonged downturn in market sentiment, with some of them only regaining access to international markets fairly recently. The more developed core countries, meanwhile, have altered their borrowing characteristics to become less reliant on short-term foreign borrowing than in the past. Many of these countries have strong enough external balance sheets and access to capital to withstand any volatility.

With tariffs specifically, markets will also be determining which EMs have a higher share of household consumption in their GDP and a higher share of services in their export basket, as well as those that have the fiscal and monetary headroom to support their economies if needed.

Investing in this environment

EM credit

EMs with lower external vulnerabilities and smaller internal imbalances offer greater market resilience and more flexibility for policymakers to address external risks. That said, spreads are generally fairly tight in these higher-rated economies. Currently, we see opportunities in certain Latin American corporates, where companies are expected to have a competitive advantage due to the relatively lower tariffs imposed. Additionally, the companies and sectors we favour are generally not overly dependent on the US.

Exchange rates

In theory, the dollar should be stronger because there is greater demand for US dollars and lower demand for foreign currencies. But longer term, tariffs may reduce US growth, leading to lower real rates, which both tend to weaken the dollar. Current dollar weakness likely reflects the lack of clarity on tariffs and their impact on US growth.

As well as any impact from the dollar, EM currencies could be more directly impacted through the trade channel and growth concerns/market sentiment. Regionally, EM Asian currencies might weaken the most, especially if this supports exports in the face of tariffs. CEE could fare better given their higher correlation to the euro, while Latin American currencies could outperform given the region’s relatively better outcome.

EM local currency debt

During the pandemic, many major EM central banks allowed weaker currencies and cut interest rates to support growth. We could see a similar approach now, especially given current levels of real rates, inflation dynamics, lower commodity prices, and the softening dollar. More developed EM countries might focus more on their domestic mandates, relying less on guidance from the Federal Reserve.

We anticipate the most policy easing in Asia, where inflation is at or below target levels and real interest rates remain in restrictive territory. There are several opportunities in Asian duration, particularly in Indonesia, which offers high real rates and stable low inflation. India's large deficits are mitigated by local funding and a multi-year tightening trend, making it an attractive option for longer-duration investments.

We also see duration opportunities in Latin American countries. Mexico and Brazil are particularly noteworthy, both offering relatively high yields. Mexico is experiencing a slowdown in inflation and economic activity, combined with a relatively stable currency, which should pave the way for further rate cuts. Brazil has historically been less affected by tariff-induced volatility due to its relatively closed economy, and aggressive rate hikes have helped stabilise its macroeconomic environment.

Overall, the high carry of select EM positions should provide a sufficient income cushion against any meaningful slowdown in global growth.

Kirstie Spence is a fixed income portfolio manager with 28 years of investment industry experience (as of 12/31/2023). She is the principal investment officer for the Capital Group Emerging Markets Local Currency Debt LUX Fund and serves on the Capital Group Management Committee. She holds a master's degree with honors in German and international relations from the University of St Andrews, Scotland.