Developing economies: the emerging and the submerging

Until this year, the emerging markets story has been one of a four-year boom, accompanied by a raised level of volatility that was inescapably part of the package. But, goaded by the wholesale market paranoia about riskier assets, the encounter with volatility in this area has mutated from what was at worst a muddy ruck into a knock-down drag-out brawl.

There are a number of catalysts for this turn-round in fortunes, one of which has been investment funds' scramble for liquidity as investors ramp up the scale of redemptions. The vehicles heading the drive to cash in are the hedge funds which have been both highly leveraged and risk-insouciant in their more adventurous investment activities. Once the double whammy of de-leveraging and a run on redemptions kicked in, these funds had to offload assets in fire sale conditions, and the higher-yielding emerging markets holdings were top of the list. Once the hedge funds started pulling out, this was enough to spook everyone else with stakes in developing economies and send them scurrying for the exit too.

Combine this with the reversal over recent weeks for countries that depend on single-theme sources of income, and particularly those whose principal exports are key commodities such as oil and foodstuffs. It is the case that marginal oil-producing states can prosper very well when oil is selling for $100-plus per barrel, but their infrastructure is not efficient enough to make any money when demand destruction drags the price below $90. At the last count, oil prices were around a third down on this pivotal figure.

Then we have, for example, Argentina's reliance on farm exports and the tax brake that its government has imposed on this foreign earnings stream. A Standard & Poor's downgrade of the country's debt Standard and Poor's to junk status reflects the impact on prospects for the country's frangible economy. And, with a polity and a financial infrastructure that, in more than the geographical sense, are a long way south of the Rio Grande, there is little hope for investors here.

But these examples are by no means typical of the whole picture: to classify Brazil, say, along with Argentina and oil-dependent Venezuela as part of an overall Latin American sinkhole would be to ignore important differences in these countries' medium-term prospects. It is some time now since Brazil was the profligate, economically feckless racker-up of foreign debt. The reforms of the past few years have produced both a responsible fiscal framework and a better-managed economy. This has been accompanied by major diversifications away from a heavy reliance on commodities, and foreign reserves substantial enough allow the country to weather the global economic storm. The International Monetary fund forecasts a Brazilian GDP of 5.2 per cent for 2008, dipping to a still positive 3.5 per cent next year - numbers that most developed countries battle to achieve in the good times.

Few people enter this area of investment with the idea that it will be a smooth ride to a fast buck, and most understand that a longer-term view is the key to riding out its inherent volatility. In the extraordinary conditions today there may well be compelling reasons to cut and run, but investors who are indiscriminate in jettisoning emerging markets positions could be passing up opportunities that are best placed to flourish when the tide starts to turn.