By Federico Galizia and Susan Lund
The G20 has delivered a strong message that multilateral development banks (MDBs) need to be “better, bigger, and more effective.” That’s the headline of the G20 reform plan adopted in November 2024, which not only sets out the future path but also establishes how to get there with a detailed roadmap of 13 recommendations and 44 actions.
A key part of this guidance is for MDBs to mobilize more private capital for development, alongside efforts to leverage more financing from their own balance sheets. It is a goal that the World Bank Group and other MDBs are moving fast to achieve, with ambitious near-term targets in sight. This includes mobilizing $65 billion in climate finance for low- and middle-income countries by 2030. The private sector is also pivotal to meeting the World Bank Group and African Development Bank’s aim to connect at least 300 million people in Africa with electricity access by 2030.
To meet these targets, though, we need to be clear-eyed about the obstacles that hold back private capital from entering emerging markets. That includes, among other factors, the question of risk.
From currency depreciation and regulatory uncertainty to difficulties in enforcing contracts, there is no doubt that investing in emerging markets entails risks. But in aggregate, how risky are such investments? The answer has come into better focus thanks to the Global Emerging Markets Risk Database (GEMs) Consortium, an initiative that involves 26 MDBs and development finance institutions. It pools data on default and recovery rates for around 18,000 development projects, totaling over half a trillion dollars, from 1994 to 2023. GEMs is the largest credit risk database for emerging markets, designed to drive investment to developing countries by helping investors better assess the risks.
Analysis of the GEMs data by the International Finance Corporation (IFC), the private-sector arm of the World Bank Group, challenges the perception that emerging markets are high-risk environments.
Take the average default rate, for instance. At 3.6 percent, loans to private sector firms in the GEMs portfolio performed similarly to many non-investment grade firms in portfolios dominated by advanced economies. For example, global corporations rated B by Standard and Poor’s and those rated B3 by Moody’s saw default rates of 3.3 percent and 4 percent, respectively.
More importantly for global investors, default rates in the GEMs portfolio display a low correlation with default rates globally for corporations with similar risk ratings. Across the six major periods of global economic stress over the past three decades, default rates for emerging market firms in the GEMs portfolio did not rise as much as default rates for similarly rated corporates in advanced economies. During the 2008 global financial crisis, for instance, default rates in the GEMs portfolio were lower than for advanced economy comparators. In other words, advanced economy investors who included emerging markets in their portfolios reaped diversification benefits when most needed.
One of the most compelling findings from the GEMs data is the disconnect between a country’s sovereign risk rating and the default performance of its corporations. Sovereign ratings have long been a significant factor in how investors assess the risk of private-sector lending and investment in a country. However, the GEMs statistics show that relying too heavily on sovereign credit ratings may lead investors to misjudge corporate risk in emerging markets.
For example, in lower-income countries the average default rate for private borrowers was 6 percent, less than half the default rate that might be expected based on their sovereign credit ratings (14 percent). The divergence between private sector default rates and those implied by sovereign ratings narrows significantly as country income levels increase. Likewise, the gap shrinks when considering countries with better sovereign ratings.
But what happens when defaults occur? GEMs statistics show that these assets also have higher-than-expected recovery rates. On average, investors in GEMs loans to private sector counterparts recover 72 percent of their investment after a default, outperforming Moody’s Global Loans at 70 percent, Moody’s Global Bonds at 59 percent, and JPMorgan’s Emerging Market Bonds at 38 percent. These higher recovery rates suggest that even when defaults take place, investors in emerging market firms are not at all left empty-handed.
MDBs, which invest heavily in local expertise and in-country staff, can play a pivotal role in demonstrating the viability of projects in markets that have not historically seen large foreign direct investment flows. They can provide advisory services to companies to improve their financial management and governance as well as structure and finance projects and supervise implementation of these projects through the life of the loan. These actions help mitigate project and borrower risks and contribute to both lower defaults and higher recovery rates. The good news for global investors is that IFC and other development finance institutions are looking to rapidly scale up their mobilization of private capital and are creating new vehicles to do so.
The evidence is clear. By incorporating emerging markets into global portfolios, investors not only stand to benefit from diversification but they can also play a role in supporting the long-term development of economies in greatest need. This bodes well for the G20’s call to scale up private capital for development—and the ability of multilateral development banks to answer it.
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