Between 10 May and 20 June, according to Maarten-Jan Bakkum of ABN-Amro Asset Management, shares in emerging market countries, which include giants such as India and Brazil as well as economic minnows like Egypt and Pakistan, plunged on average by 20%. In some markets, the falls were much steeper.The prices of bonds and the international value of many of these countries’ currencies clattered down with their stock markets. The prices of commodities, some of which are vital to certain developing economies, slid too. For some economists, the falling prices raised the question: are we on the verge of another developing country financial crisis? Or is this just a market correction which is already petering out as inflated asset prices return to more realistic levels and investors pay more attention to the improved medium-term economic foundations which many developing countries have constructed since the crashes of 1997-98?The answers are important not just to footloose speculators but also to governments, companies and the ordinary citizens of these countries. On 31 May the World Bank, in its 2006 Global Development Finance report, disclosed that in 2005 a record $491 billion (€391.4bn) of net private capital flows had poured into developing countries, compared with $154bn (€122.7bn) in 2001. The IMF’s Rajan says that in future, in a global economy, policymakers in the US, Europe and Japan will need to think more about the way in which their economic policies spill over into emerging markets and developing countries.Hans Timmer, manager of the World Bank’s Global Trends Team, was already warning at the time of the market turmoil in May that “high oil prices, rising interest rates and building inflationary pressures are expected to restrain growth in developing regions over the next two years”. But he said: “These regions are still expected to out-perform high-income economies.”If, however, tens of billions of the near $500bn of private capital which the World Bank says flooded into developing countries in 2005 are even now in the process of flooding out again, then there may well be trouble ahead for the weaker developing countries. The money flooded into privatisations of state-owned assets, mergers and acquisitions, external debt re-financings and bond markets, the bank said, helping to lift growth in developing countries’ gross domestic product (GDP) to 6.4%, more than double the advanced economies’ rate of expansion, propelled by a near 10% expansion in China and 8% in India. The World Bank refrained from saying that billions upon billions of the inflow was also ‘hot money’, triggered by speculators’ ability to borrow in countries such as Japan at rates of 1% or 2% and then, for example, invest for a while at five or more times this level in developing country securities, part of the so-called carry trade. Provided, that is, that they took the currency risk.What does all this have to do with development? Put simply, it highlights just how dramatically globalisation and the integration of world financial markets have transformed the economic policy calculus for all but the poorest countries.Private capital flows have long outstripped official development finance, but never by so much as now and never through such a diversity of different financial institutions and instruments, from plain vanilla bank loans to complex credit derivatives, from hedge funds to pension funds. Many would argue that this is all to the good, that aid is too blunt an instrument to create development, even that it is counterproductive and that private capital is vital. At present, much of this private-sector business, particularly the financial flows, is so-called north-south transactions, between rich, advanced economies and medium-income developing nations. But south-south financial flows are increasing. South-south foreign direct investment (FDI), where investors build factories or build banks, for example, hit $47bn in 2003 according to the World Bank, 37% of the developing countries’ total FDI. South-south trade, another engine of development, almost tripled from 1995 to $562bn in 2004, the World Bank says, and accounted for a quarter of total developing country trade. So what is the significance of the recent slump in emerging financial markets? Is it just a summer storm or are there forces at work which will require policymakers, in both the developed and the developing world, to re-engineer their economic toolboxes as they did after 1997-98? Since those crises, those developing and emerging market countries that have been able to, have built up their defences. Some have constructed mountainous foreign exchange reserves ($1,000bn in China alone), partly to insulate themselves from investor panics, and fought to get their current account balances into surplus and their budget deficits under control. They have reduced their public sector debt and financed more of it domestically, limiting their exposure to devaluation.Many (China is a notable exception) have been more careful about pegging their currencies to the US dollar. Some are curbing the freedom of their banks and citizens to borrow heavily in foreign currencies, so exposing themselves and their nations to the devaluation risk which was at the heart of the initial Asian meltdown in 1997.But the international context has changed, too. The US, western Europe and Japan, have been living through the longest period of low interest rates since the ten years after Second World War. In response their investors have been stretching for yield, chasing riskier higher returns or trying to ‘goose up’ their performance through leveraged investments, not just with the notorious hedge funds, but also in pension and insurance funds. In a speech at the beginning of this month Raghuram Rajan, director of research at the International Monetary Fund (IMF), the government-owned international financial institution, suggested that such riskier investment strategies may be “amplified when interest rates are low”. So has there been a bubble, fuelled by low interest rates, in emerging market assets and some commodities, similar in some ways to the bond market and housing bubble in advanced economies and the dot.com bubble in 1999-2000? If so, now that central banks around the world are withdrawing liquidity, ie raising interest rates, to fight inflation, is this emerging market bubble bursting? Are developing countries, particularly the weaker ones, going to have to put their economies through the wringer yet again in response to rising interest rates, slower growth and an increased aversion to risk in the advanced economies?