Geopolitical risk raises EM sovereign credit costs
A new Bank for International Settlements working paper finds that geopolitical risk significantly raises sovereign credit default swap (SCDS) and bond index (EMBI) spreads in emerging markets. The study highlights stronger impacts from threats and in post-invasion periods.
Threats over acts, post-invasion amplification
A new Bank for International Settlements (BIS) working paper reveals three key findings on geopolitical risk (GPR) and emerging market sovereign credit.
First, an increase in the GPR index significantly raises both sovereign credit default swap (SCDS) and J.P. Morgan Emerging Markets Bond Index (EMBI) spreads, with the SCDS showing a larger response.
Second, disaggregating the GPR index into 'threats' and 'acts' subcomponents demonstrates that threats elicit a larger response in spreads than actual events, suggesting anticipation effects in sovereign credit markets.
Third, the study highlights a substantially different response around the 2022 Russian invasion of Ukraine, where the post-invasion environment amplified the sovereign risk premia response.
The analysis uses monthly data on SCDS and EMBI spreads for 13 emerging market economies from January 2005 to October 2025.
Modeling state-dependent shocks
The paper employs a fixed-effects panel local projections framework, extended for state-dependent transmission.
This innovative approach attributes impulse response differences to specific macro-financial fundamentals, offering a nuanced understanding of how geopolitical events influence sovereign credit markets.
The IMF identifies two channels for geopolitical risk impact: an economic channel (trade disruptions, fiscal vulnerabilities) and a market sentiment channel (heightened uncertainty, risk aversion).
The study's joint analysis of SCDS and EMBI spreads provides a comprehensive view of sovereign risk dynamics, addressing a gap in literature that often uses aggregate risk measures.
Beyond the aggregate index
This paper provides crucial nuance to understanding geopolitical risk transmission.
Its focus on state-dependent effects and the distinction between threats and acts moves beyond simplistic aggregate analyses.
For policymakers, this offers a more granular tool to anticipate and mitigate sovereign risk in volatile emerging markets.