By: Udaibir Das
This article originally appeared in OMFIF on January 9, 2026.
Institutional autonomy, not the cycle, will shape outcomes
Global financial institutions continue to frame the 2026 outlook for emerging markets through a familiar cyclical lens. The consensus assumes US monetary easing, a softer dollar and a modest global slowdown will favour local-currency assets, credible disinflation paths and balance-sheet repair. This narrative is historically grounded and internally coherent. It is also increasingly insufficient.
The central risk in 2026 is not misjudging the cycle but misidentifying the constraint. Treating emerging markets as a homogeneous asset class that responds to price signals within a stable global financial regime simply no longer reflects the current operating environment.
The global financial system now operates within a fragmented institutional architecture, characterised by overlapping legal jurisdictions, competing settlement systems, closer alignment between finance and industrial policy, and the growing use of sanctions.
In this environment, the binding constraint for emerging and developing economies isn’t the marginal cost of capital, it is institutional autonomy: the capacity to run across multiple financial and regulatory systems without surrendering long-term policy space or control over strategic assets.
This constraint is not evenly distributed. Large economies with deep institutions – such as India, Brazil, Mexico and Vietnam – face a different problem from smaller, single-channel borrowers. Size and institutional capacity are not independent variables. Together, they determine whether fragmentation expands or narrows the room for manoeuvre.
The phase now underway is therefore one of differentiated institutional positioning, in which outcomes will diverge by capacity and scale rather than converge through growth cycles. That divergence is most visible in how capital is raised and governed.
Control, not funding
Fragmentation first appears in infrastructure finance. Development finance has moved away from standard sovereign borrowing towards layered capital structures that combine policy guarantees, concessional tranches, state-linked lenders and embedded project-level control rights.
This shift coincides with a structural contraction in traditional external financing. Foreign direct investment into EMDEs has fallen from around 5% of gross domestic product before the global financial crisis to just over 2% today. This decline reflects more than cyclical risk aversion. It points to a deeper transition in which control over capital, rather than its price alone, has become central to economic sovereignty.
As the capital stack becomes the locus of decision-making, macroeconomic stabilisation is no longer sufficient. The core policy problem shifts from managing rollover risk to preserving infrastructure optionality. Decisions embedded in ports, power grids, transport corridors and digital networks generate long-lived path dependencies that shape trade patterns, technology choices and geopolitical exposure.
For large economies with diversified financing options and institutional capacity, such commitments can be absorbed and, if necessary, renegotiated. For others, they hard-wire dependence. By 2026, control over the capital stack will be a central determinant of resilience, but only where scale and institutional depth make that control meaningful. The same asymmetry is now emerging in the payments system.
Settlement efficiency and the diagnostic challenge
Much public debate continues to focus on de-dollarisation. The more consequential development lies elsewhere: rapid improvements in cross-border settlement infrastructure. Platforms such as Project mBridge and related wholesale digital-currency arrangements have reduced settlement times and lowered transaction costs.
Settlement efficiency, however, is not external balance. Faster payments reduce friction without altering underlying trade structures. Capital goods and high-value intermediates can be imported with increasing ease, while exports in many emerging economies remain concentrated in volatile or lower value-added segments. In several non-commodity EMDEs, non-oil trade deficits have widened even as exchange-rate volatility has declined.
This creates a diagnostic challenge. For large, institutionally capable economies with access to multiple financing channels, wider trade deficits may be manageable. Settlement efficiency reduces financing friction and expands options. For economies without such access, the same dynamics increase vulnerability. Smooth settlement, stable reserves and calm currencies can obscure deteriorating external positions until adjustment becomes unavoidable.
The frictionless deficit is most dangerous where institutional capacity to manage it is weakest. Settlement efficiency can delay adjustment, but it cannot resolve structural trade imbalances. When global liquidity tightens or commodity prices shift, that delay translates into a sharper correction and higher tail risk.
Institutional positioning and differentiated outcomes
In a fragmented global economy, institutional autonomy matters most for large EMDEs with diverse financing options. Its effectiveness depends on three conditions: size, institutional capacity and geopolitical room for manoeuvre.
Some economies meet these conditions. India’s current positioning combines participation in western semiconductor supply chains with continued engagement with China across trade, energy and defence. Vietnam similarly integrates into US- and Japan-centred manufacturing while maintaining diversified infrastructure relationships. In both cases, optionality is preserved through scale, institutional credibility and diversified linkages.
Other economies possess institutional depth but lack optionality. Mexico both benefits materially from nearshoring under the US-Mexico-Canada Agreement and has deep capital markets. Yet its structural dependence on North American supply chains limits its ability to pivot if political or trade conditions deteriorate. Institutional strength mitigates risk, but it does not eliminate exposure.
This differentiation matters because public debt ratios across emerging markets are materially higher than in the early 2010s, compressing fiscal space and increasing the cost of policy error. For economies with diversified access, this constraint is manageable. For others, it is binding.
What 2026 will test
If this framework is correct, outcomes in 2026 should diverge by institutional positioning rather than by macro fundamentals alone.
India is the clearest test case. Its current strategy preserves optionality across systems. If intensifying US-China competition forces a binary choice – through trade escalation, technology restrictions or geopolitical shocks – then geopolitical pressure, not institutional capacity, will determine outcomes. If optionality is preserved, the institutional-autonomy thesis holds.
Rigid anchors should exhibit higher foreign exchange volatility if their dominant trading bloc weakens. Economies without diversified access to financing should face earlier stress if external liquidity tightens. By late 2026, positioning-based segmentation should explain a meaningful share of variation in spreads and capital flows. These are testable claims.
Why portfolio frameworks will struggle
A common objection is that markets price cycles, not structure, and that Federal Reserve policy will dominate emerging market outcomes. This view underestimates how institutional architecture now conditions returns.
Now, capital is increasingly non-fungible. Project-linked finance with embedded control rights does not reprice or exit like portfolio flows. It reshapes the opportunity set itself. Improved settlement infrastructure delays adjustment rather than eliminating it, increasing tail risk. Portfolio flows still matter, but they increasingly follow rather than drive institutional decisions.
The geopolitical constraint
Multi-system positioning remains viable only within the bounds of geopolitical tolerance. If US-China competition forces binary alignment, optionality collapses. Russia and Iran mark the extreme, but the more immediate risk is choice-forcing for middle powers such as India, Vietnam and Mexico.
The standard emerging markets playbook – built around cycles, spreads and carry – has reached its analytical limits. By late 2026, geopolitical pressure may supersede institutional capacity as the binding constraint.
For policy-makers, the challenge is preserving policy space. For investors, it distinguishes genuine flexibility from apparent resilience built on fragile foundations. Returns will accrue to structure, not speed, only where structure is real and sustainable under stress.
Udaibir Das is a Visiting Professor at the National Council of Applied Economic Research, a Senior Non-Resident Adviser at the Bank of England, a Senior Adviser of the International Forum for Sovereign Wealth Funds, and a Distinguished Fellow at the Observer Research Foundation America.