European Central Bank warns: How global financial stability risks impact emerging markets

Emerging Market Risk Exposure in the Global Financial Stability Landscape

In its Financial Stability Review released in November 2025, the European Central Bank (ECB) pointed out that global financial stability risks remain high. Although the alarm over escalating trade wars since April has somewhat subsided, the structural nature of trade policy uncertainty remains unchanged, and concerns about US fiscal sustainability and the risks of geoeconomic fragmentation are intensifying. For emerging markets, this report essentially outlines a clear transmission path from core risks in developed countries to the Global South.

The US "Twin Deficits" and the Loosening of the Global Interest Rate Anchor

The ECB report particularly emphasizes that market concerns over the long-term fiscal sustainability of the United States are undermining the traditional "safe-haven" status of US Treasuries and the dollar. The persistent high fiscal deficit and current account deficit (the "twin deficits") in the US are leading to a steepening of the yield curve, while doubts about central bank independence are further shaking investor confidence. This shift is crucial for emerging markets—once the anchor of the global risk-free rate begins to waver, it will trigger a drastic reallocation of international capital flows. Historically, every major adjustment in US interest rate expectations has led to capital flight and currency crises in emerging markets (e.g., the 2013 "taper tantrum"). Currently, if the risk premium on US assets continues to rise, funds may flow back from emerging markets to dollar-denominated assets (even as the dollar itself weakens), thereby causing a sudden tightening of financing conditions for emerging markets.

The Dual Effects of Euro Area Vulnerability and Trade Transmission

The report notes that the euro area, as a highly open economy deeply integrated into global supply chains, is highly susceptible to spillover effects from trade frictions and exchange rate fluctuations. In the preface, ECB Vice-President Luis de Guindos mentioned that if pressure on global bond markets arises due to sovereign debt concerns, it could be transmitted to the euro area through international capital flows and exchange rate fluctuations, weakening commodity competitiveness and pushing up financing costs. For emerging markets with close trade ties to the euro area (such as Central and Eastern Europe, North Africa, and Sub-Saharan Africa), a slowdown in euro area demand would directly hit export revenues. At the same time, a depreciation of the US dollar (which the report suggests may persist) would intensify competitive pressure on euro area exporters, but if emerging market currencies appreciate too quickly against the dollar, it could harm their own export competitiveness. This complex exchange rate interaction further narrows the policy space for the Global South.

Three Major Risk Sources and Their Links to Emerging Markets

The ECB categorizes current risks into three types, each of which is closely related to emerging markets: 1. Overvalued Assets and Non-Bank Financial Intermediation: Global stock markets have repeatedly hit new highs, with market capitalization concentrated in large U.S. technology companies, while hedge funds exhibit high leverage and open-end funds show significant liquidity mismatches. Should market sentiment reverse, forced selling by non-bank financial institutions (NBFIs) could rapidly spread to emerging market assets—developed market funds hold substantial stocks and bonds in emerging markets, and liquidity pressures would lead to indiscriminate selling of these assets.

2. Sovereign Debt Sustainability Concerns: Several euro area countries have weak fiscal foundations, and their investor base is shifting toward price-sensitive types. Repricing of sovereign risk faces greater difficulties in the current environment. Meanwhile, sovereign debt issues in emerging markets are even more severe: many countries accumulated large external debts during the pandemic period of 2020-2022 and now face high interest rates and currency depreciation pressures. If European sovereign risk escalates, it will push up global risk premiums, further worsening external financing conditions for emerging markets.

3. Bank Credit Risk and Interconnectedness: Euro area banks are adequately capitalized and profitable, but credit risks in tariff-sensitive sectors (e.g., automobiles, machinery) may erode loan quality. The deepening interconnectedness between banks and non-bank institutions (e.g., derivative exposures, funding dependencies) could expose banks' funding vulnerabilities under stress. Similar bank-nonbank linkages exist in emerging markets, particularly in rapidly developing capital markets such as China and India, where risks from shadow banking and asset management products warrant vigilance.