The Return of Domestic Capital

The most consequential shift in Global South finance in 2026 is not a new wave of foreign capital. It is the reassertion of domestic capital as the primary stabiliser of states, banks, and investment cycles. For three decades, the standard growth script treated foreign money as the hard capital and domestic finance as the soft constraint. That hierarchy is reversing as external funding becomes slower, costlier, and more conditional.

The turn is measurable. Outstanding sovereign bond debt in emerging markets and developing economies reached nearly $12 trillion in 2024, up from $4 trillion in 2007, according to the Organisation for Economic Co-operation and Development. Annual issuance tripled over the same period, from approximately $1 trillion to over $3 trillion, representing nearly 7 percent annual growth in US dollar terms. Yet the composition changed fundamentally. Local currency issuance now dominates, and domestic investors absorb the majority.

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The Local Currency Ascent

Excluding China and India, foreign currency denominated debt accounts for around 20 percent of total emerging market and developing economy debt, compared to just 6 percent for the OECD average, according to OECD Global Debt Report 2025. For smaller EMDEs, foreign currency debt has comprised around 40 percent of total outstanding debt since 2018. The gap is structural. Larger emerging markets with deeper domestic savings and stronger policy frameworks have been able to rely more on local currency debt issuance. Smaller and frontier economies still depend on foreign currency borrowing, exposing them to exchange rate volatility.

The cost differential is sharp. USD-denominated bond borrowing costs in EMDEs rose from around 4 percent in 2020 to over 6 percent in 2024, exceeding 8 percent for lower non-investment grade countries, according to OECD data. As a result, these countries have had negative net borrowing from foreign markets since 2022. The total cost of foreign currency debt often significantly exceeds that of local currency debt in the long term, when accounting for currency depreciation.

Bond issuance trends illustrate the reversal. Governments stepped up their borrowing mainly in their domestic currency, according to Bank for International Settlements data. Meanwhile, private sector borrowers continued to tap bond markets in foreign currency, mainly US dollars. With major emerging markets increasingly tapping bond markets in their domestic currency, the foreign currency share in EMDE government bonds has continued to decline, according to BIS analysis.

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Domestic Ownership Rising

Large emerging markets with strong policy frameworks and growing domestic savings have been able to rely more on local currency debt issuance and strong demand from domestic investors, especially nonbank financial institutions, according to the International Monetary Fund. As a result, the share of debt issued in local currency and owned by foreign investors has fallen to multiyear lows in many countries.

Domestic banks' holdings of sovereign bonds have continued to rise and reached almost one fifth of banking sector assets in major emerging markets and low-income countries in 2021, according to the IMF. This led to a sharp increase in sovereign-bank nexus across most EMDEs from 2020 to 2022. IMF Working Paper analysis shows that bond yields in EMDEs are becoming increasingly sensitive to fiscal fundamentals, reflecting increased domestic banks' exposure to public debt as well as gradually strengthened local currency bond markets.

Greater domestic ownership of local currency debt reduces the sensitivity of emerging market debt to global shocks, according to analysis in the IMF Global Financial Stability Report October 2025. With more domestic ownership, bond yields rise less than they would otherwise in a risk-off scenario. The stabilizing effect of domestic investors on bond yields appears to be especially true for banks. IMF analysis shows that a risk-off shock is associated with a 19 basis point increase in local currency yield spreads, but a one standard deviation increase in domestic bank ownership share mitigates that effect to 11 basis points.

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Pension Assets: The Domestic Anchor

Global pension savings reached $63.1 trillion at the end of 2024, according to the Organisation for Economic Co-operation and Development. For the OECD's 38 member countries, this translated into 98 percent of their combined gross domestic product, almost three times the level 20 years earlier. Including all 87 reporting jurisdictions globally, pension assets totaled $68.5 trillion at end 2024.

Since 2013, pension assets in advanced economies have grown by nearly 6 percent annually, with significant volatility, according to OECD Global Pension Statistics. Growth in emerging economies reached almost 9 percent annually over the same period. In advanced economies, pension assets have nearly doubled as a share of GDP to an average of 55 percent, exceeding 100 percent of GDP in eight countries, according to the OECD Pensions Outlook 2024.

This global trend is not limited to advanced economies. Many emerging and developing economies also have pension funds with hundreds of billions of US dollars in assets. The amount of pension assets varies widely across regions. North America recorded $48.2 trillion in assets under management, representing over 70 percent of total assets accumulated globally in 87 jurisdictions. Europe had the second largest pool at $9.7 trillion. Pension providers in Asia managed assets worth $4.3 trillion, or 12.5 percent of the combined GDP of reporting Asian jurisdictions.

Asia is one of the regions accumulating the largest reserves to support public pension systems, at $3.1 trillion or 11.4 percent of GDP in 10 jurisdictions. Within Asia, pension assets range from less than 1 percent of GDP in Pakistan to 82 percent in Singapore. In Africa, assets range from 1 percent of GDP in Egypt to over 100 percent in Namibia, according to OECD data.

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The Sovereign-Bank Nexus: Stability and Risk

The rise of domestic capital mobilization through local currency bond markets supported by domestic institutional investors has provided emerging markets with greater resilience to external shocks. Yet the concentration of sovereign debt holdings among domestic banks creates new vulnerabilities. With public debt at historically high levels, a deeper sovereign-bank nexus poses risks of doom loops to escalate, according to IMF analysis.

In countries with low savings, narrow investor bases, and poor financial market infrastructure, excessive sovereign debt holdings can lead to problems. Large holdings of sovereign debt by banks can reduce their capacity to lend to the private sector, which may in turn reduce economic growth, according to IMF research. In addition, sovereign defaults can lead to large losses in the banking sector, ending in expensive and difficult bank bailouts.

The policy challenge is to deepen local currency bond markets while avoiding financial repression. IMF Global Financial Stability Report October 2025 contrasts major emerging markets that have largely been able to expand borrowing through increased local issuance to local investors, with other emerging and frontier markets that have needed to rely on shorter maturity financing from domestic banks and the central bank, as well as foreign currency debt. This could deepen the divergence between more resilient and more vulnerable economies if shocks appear.

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Home Bias By Design

Domestic capital's return is often engineered. Governments encourage local institutions to absorb issuance, recapitalize development banks, and use regulation to increase domestic demand for domestic paper. This stabilizes refinancing, but can squeeze private credit if domestic institutions face implicit or explicit pressure to prioritize sovereign debt over private sector lending.

The turn toward domestic financing reflects both opportunity and constraint. Digital financial infrastructure is pulling informal liquidity into formal channels, expanding state capacity and widening domestic funding options. Pension fund growth, insurance reserves accumulation, and banking sector deepening create larger pools of domestic savings available for sovereign borrowing.

Yet domestic capital markets remain shallow in many emerging economies. The investor base is narrow. Banks dominate, creating concentration risk. Nonbank financial institutions are growing but from a small base. Retail participation is limited. Liquidity is thin compared to advanced economy markets. These structural constraints mean that domestic financing, while more stable than foreign capital flows, carries its own vulnerabilities.

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Trust Is The Constraint

Domestic savings are stable only while people trust inflation control and rule continuity. When trust breaks, domestic money behaves like foreign money and flees. Capital controls can slow exit but cannot prevent it entirely. The difference between domestic and foreign capital is not immobility but confidence.

Countries should prioritize efforts to improve the implementation and credibility of their policy frameworks, preserve central bank independence, and rebuild spending capacity for when it is needed, for example during an economic downturn, according to IMF recommendations. With continued reforms and stronger foundations, emerging markets can turn hard-won resilience into long-lasting stability.

The allocation question determines outcomes. Domestic capital can fund infrastructure, upgrading, and productivity growth. Or it can finance consumption, refinance old obligations, and delay adjustment. If domestic savings primarily roll over existing debt rather than fund new investment, they become survival finance rather than development finance. Governance and institutional quality determine which path prevails.

After decades of dependence on external capital, the Global South is funding itself. The shift reflects resilience gained through better policy frameworks, deeper local markets, and stronger institutions. Yet it also reflects constraint: external capital has become selective, expensive, and conditional. Domestic capital fills the gap. The winners in 2026 will be those that treat domestic capital as a contract requiring credibility, not captive liquidity to be extracted.