Iran war whiplash shows how fast foreign money can flee – and rush back – to EMs
Foreign capital now supplies most of emerging markets’ funding – and it can bolt at the first sign of a geopolitical shock.
Reuters reported that, according to the International Monetary Fund (IMF), emerging market nations now receive most of their foreign financing from hedge funds, pension funds and insurers, which “significantly benefits emerging markets” by offering longer‑term, lower‑cost debt but also leaves them “particularly vulnerable to global financial shocks.”
The share of cash flowing into emerging market debt from portfolio investors has doubled over the past 20 years to 80 percent, as banks backed away from lending following the 2008 financial crisis, with cumulative inflows of close to US$4tn since then.
As per the Financial Times, purchases of emerging market stocks and bonds by foreign investors have increased eightfold since the crisis, with cumulative inflows approaching US$4tn in 2025, mostly in the form of debt.
Debt held by foreign investors now averages 15 percent of GDP in emerging markets, up from 9 percent in 2006, while portfolio equity liabilities average about 7 percent of GDP, the IMF said.
IMF staff told the Financial Times that four‑fifths of this capital now comes from non‑bank sources such as hedge funds and investment funds, double the share seen two decades ago.
The IMF warned that these flows “tend to be more volatile than bank flows and are increasingly sensitive for global risk conditions”, and said the risks have “come to the fore in the context of the war of the Middle East.”
It highlighted hedge funds and investment funds as far more reactive to risk than other portfolio investors.
According to the Financial Times, a jump in the Vix volatility index of around 7 percentage points led to a 1.3 percent fall in hedge funds’ holdings of emerging market securities, compared with a 0.6 percent decline in mutual funds’ holdings and no significant change for insurance companies and pension funds.
Reuters reported that the IMF estimated external portfolio debt liabilities at about 15 percent of GDP in emerging markets, and equity portfolio liabilities at around 7 percent of GDP, and noted that foreign portfolio holdings “represent an economically meaningful share of stock market capitalization in some emerging markets.”
It said foreign portfolio holdings are particularly large for currencies such as Hungary’s forint, which “propelled it to 20 percent gains against the US dollar last year” before the forint “wilted since the Iran war began” as flows into emerging markets weakened.
The Iran war, which began in late February and quickly spread across the region, spiked oil prices by 50 percent to above US$100 per barrel and “sapped investors’ risk appetite.”
Reuters said the Institute of International Finance (IIF) estimates that foreign investors pulled US$70.3bn from emerging market assets in March, marking the biggest outflow since the March 2020 pandemic rout.
The IIF called the move a “sharp regime break following a major geopolitical shock.”
Outflows from emerging equities, especially in Asia, drove much of the reversal, with US$56bn leaving emerging stocks — the largest such loss in at least 20 years.
The IIF described March as a “concentrated risk-off episode” rather than a “fully generalized EM funding event”, with overall debt outflows at US$14.2bn and inflows of US$2.5bn into China, Reuters reported.
Latin America equities remained in positive territory, drawing US$1.4bn.
The IIF said emerging Asia proved vulnerable to high oil prices and “technology-linked equity repositioning”, noting that South Korean stocks gained close to 50 percent in the first two months of this year before giving up just over a third of that after the war began.
The World Bank warned that emerging and developing economies in Europe and Central Asia face a sharp slowdown under a scenario of a large but temporary rise in energy prices from the conflict in the Middle East.
Its updated outlook sees growth across the region slowing to 2.1 percent in 2026 from 2.6 percent in 2025, with a slightly higher 2.9 percent if Russia is excluded.
The lender’s baseline scenario assumes Brent oil prices averaging US$88–US$100 per barrel this year, as well as higher gas and fertiliser prices.
