EMERGING MARKETS-Emerging markets set to end year with blockbuster gains

By Niket Nishant

Dec 31 (Reuters) - Emerging market assets were on track to end the year with the biggest gains since 2017, as trade policy shifts and stretched valuations in the U.S. prompted investors to look for more attractive opportunities elsewhere.

Their focus will now shift to whether regional markets can sustain the momentum next year as tariff-related frictions persist and several emerging market countries head toward elections.

The MSCI index of emerging market currencies .MIEM00000CUS was poised to end 2025 with gains of more than 7.2%, thanks in part to expectations of a weaker dollar because of the Federal Reserve's rate cuts.

Stocks .MSCIEF were on track for returns of over 30% in 2025, their best performance since 2017.

DOMESTIC FACTORS DRIVE SENTIMENT

The rally was not purely driven by Fed expectations, as economies with stronger fiscal backdrops and policy support outperformed. The global AI boom propelled South Korean shares .KS11 up nearly 76%, for their strongest year since 1999.

China's blue-chip CSI300 Index .CSI300 and the Shanghai Composite Index .SSEC also jumped more than 18% each, with the Shanghai benchmark logging its strongest performance since 2019.

Beijing has promised to implement more proactive policies to support long-term growth and boost domestic demand. Data earlier this month showed that China's trade surplus topped $1 trillion for the first time ever.

The coming year may create opportunities for investors to rebalance and adjust country allocations to maintain the right mix of exposures, and investors will also hope for more clarity on the trade front.

A prolonged delay in the U.S.-India trade deal has weighed on the Indian rupee INR=IN, which is nursing its worst annual drop in three years.

"We still like the tech-sensitive equity markets across Korea, Taiwan and China, but prefer rotating some of the portfolio weights into more domestic-oriented markets of South Africa, India and Brazil for better balance," Goldman Sachs economists wrote in a note.

In Europe, the main stock benchmarks of Prague .PX, Budapest .BUX and Bucharest .BETI hit record highs on Tuesday, the final trading day of the year.

The Hungarian forint EURHUF= and the Czech crown EURCZK= were the best-performing currencies in the region, gaining 6.4% and 4% this year, respectively.

The next leg of returns may hinge on the direction and pace of monetary policy in each market.

GEOPOLITICAL RISKS IN FOCUS

The unresolved Russia-Ukraine war remains a big uncertainty for markets, and the lack of significant progress towards a settlement despite months of diplomatic effort has made investors uneasy.

The war could have major implications for sentiment towards regional assets, particularly as some investors weigh increasing allocation to emerging market bonds.

Geopolitical risks are also resurfacing elsewhere, most recently in the tensions between Saudi Arabia and the United Arab Emirates, two major Gulf powers and oil producers.

The UAE said on Tuesday it was pulling its remaining forces out of Yemen after Saudi Arabia backed a call for UAE forces to leave within 24 hours.

Saudi Arabian equities .TASI gained 0.9% on Wednesday after dropping 1% in the previous session. Dubai's main share index .DFMGI also edged 0.8% higher, a day after recording its biggest intraday fall in more than six months.