Which ESG Factors Matter to EM Sovereign Bond Investors?

With the IMF-World Bank Spring Meetings now behind us, I’ll be releasing my semi-annual sovereign risk assessments for over 40 emerging and frontier markets, based partly on the latest IMF World Economic Outlook data. I’ll provide a sneak peek at some of those results here. For full results, Tellimer subscribers will be able to access this premium product via the Sovereign Vibe channel on the Tellimer platform, while others will be able to purchase it on my website. More details to follow in subsequent newsletter editions here.

As Trump 2.0 policies rapidly erode the safe haven status of U.S. Treasury bonds, sovereign debt market plumbing and geographic diversification are already major themes for asset allocators in 2025.

So the IMF release of a working paper on April 11th, “Do ESG Considerations Matter for Emerging Market Sovereign Spreads?”, is timely, to say the least. Indeed, Trump’s EM-ification of the U.S. helps explain this year’s upward pressure on Treasury yields and downward pressure on the dollar.

The upshot from this paper is that IMF staff find ESG factors to have an effect on said spreads. A shocker, I know.

Yet looking under the hood reveals some counterintuitive results, so let’s unpick them, shall we?

The nitty gritty

EM sovereign spreads refer to the difference in yield of a dollar-denominated EM government bond over U.S. Treasury bonds of equivalent maturity. The higher the spread over Treasuries, the higher the perceived sovereign risk on that bond by the market.

Using J.P. Morgan EMBIG data, the authors measure spreads for 79 emerging and developing economies over 2001-2021 and consider how several ESG and non-ESG factors are linked to changing spreads. Many of the explanatory variables are domestic, including income, growth, fiscal and external balances, governance, and GHG emissions. Others are global, including global risk sentiment and U.S. interest rates.

Blast from the past

As you may have noticed, there’s an awful lot of “non-ESG” among these independent variables. This makes sense because past research uses many of the same metrics, which helped the authors estimate a robust model that explains much of the variance in changing sovereign spreads (R-squared = 0.424).

Look at this model from the IMF’s own Debt Sustainability Framework for Market Access Countries, used to estimate the probability of sovereign stress 1-2 years ahead. There is plenty of overlap between the two models, not only on debt and international reserves, but also on governance. “Institutional Quality” is the average of the WGI indicators on “Government Effectiveness” and “Regulatory Quality,” both listed in the new ESG paper.

Income, and then some

Here's the thing, though. The authors found that changes in purchasing power-adjusted income-per-capita have by far the greatest impact on emerging market spreads. While they try to pass off population purchasing power as a social aspect, in my book it’s a purely economic one.

As for the other indicators, the impact that each one has on spread changes is about 3-6x weaker than income. The exception is GHG emissions per capita, which barely matters at all!

It’s all good, G

The takeaway is clear. For example, if an emerging economy needs to expand fossil fuel-powered electricity coverage, it can do so without worrying that an increase in its (already-low) emissions per capita will have much of an impact on its sovereign borrowing costs.

And it shouldn’t: climate risks for sovereign issuers are a climate adaptation problem, whereas emissions are a climate mitigation problem.

Conversely, the ESG factors that do matter – regulatory quality, government effectiveness, and control of corruption –fall into the Governance category.

As ructions persist across U.S. Treasuries and EM sovereign debt markets alike, policymakers from Washington to Windhoek to Warsaw would do well to remember that good governance means good borrowing terms.

Disclaimer: The content provided in this newsletter is for informational purposes only and should not be construed as financial, investment, or other professional advice. While I strive to ensure accuracy, I make no guarantees regarding the completeness or reliability of the information presented. Readers are encouraged to conduct their own research and consult with qualified financial professionals before making any investment decisions. The author and publisher are not responsible for any actions taken based on the information provided.