At some point, a market has to stop emerging, and some of the markets of emerging Europe are reaching this stage. What does it mean, for example, to describe Slovenia, which joined the eurozone a year ago, as an emerging market? Cosmetically, Ljubljana, its capital city, resembles a prosperous provincial town in neighbouring Austria far more than it resembles chaotic Bucharest, a few thousand kilometres to the east. Further, Slovenia joined the eurozone at the beginning of 2007. If inflation remains persistently high in the country, it is still hard to identify any of the economic factors that traditionally justify an emerging market risk premium.

There is no currency risk involved when a country uses the world's second most widely-held reserve currency as a medium of exchange. And what political risk is there to speak of when Slovenia currently holds the presidency of the European Union, the first of the east European countries to do so?

To be sure, Slovenia's stock market is small and illiquid. Stock prices rose sharply in the year following eurozone membership. This did not reflect any sharp improvement in investor sentiment. Rather, the country moved from the major index providers' emerging Europe indices to the eurozone indices, creating huge inflows as benchmark-driven fund managers adjusted their holdings accordingly.

Justifiable concerns

Investors continue to have concerns. Some criticise the continuing high levels of state ownership. Most of the largest companies on the Ljubljana Stock Exchange are still partially owned either directly by the Slovenian government or indirectly by one of the government-controlled investment buffer funds, and foreign investors have had their fingers burned in the past. In 2004, the government sold a 35 per cent stake in Nova Ljubljanska Banka, the country's dominant bank with profitable operations throughout the fast-growing markets of south-east Europe, to Belgium's KBC bank, with the promise of first refusal on an expected later tranche. KBC had every reason to expect to gain full control of the bank within a few years, but no further sale has been forthcoming.

But high levels of state ownership are hardly a characteristic particular to emerging markets. After all, the German state of Lower Saxony continues to own a significant stake in Volkswagen.

Ashmore's Jerome Booth has a rule of thumb to establish which markets are developed and which are emerging. “A developed country is one that can be fiscally irresponsible and get away with it,” he says. Belgium and Italy can run vast budget deficits for years on end without facing a fundamental loss of investor confidence. Emerging economies are subject to stricter scrutiny, and investors are more likely to take flight.

But even here, the countries of central Europe in particular are in an ambiguous position. EU membership appears to have a soothing effect on investors. “It is interesting that the current account deficit countries in the emerging markets are all in Europe,” Mr Booth says. “It is not a coincidence, though. It is because they have been able to finance those deficits and have an electorate that demands that level of expenditure. Central Europe is the test case. They are becoming developed, not because their credit quality is improving, but because they are allowed to damage their credit quality. It's about the investor base not caring.”

Emerging diplomatically

Hungary's case is instructive. For close to six years, Hungary's governments were reluctant to make politically unpopular spending cuts. Growth slowed, and the country's twin current account and budget deficits rose to ever more unstable heights. When a freshly re-elected government finally announced plans to bring spending under control, rioting erupted on the streets. Yet neither spiraling twin deficits nor the spectre of political instability fully spooked investors. The currency fell steadily, interest rates rose – but foreign investors continued to come. This may reflect a belief that long-term prospects are still bright. Patrick Cogny, who runs European operations for Genpact, a corporate services centre provider, dismisses as short-termist concerns about present fiscal instability. “Our deal cycle typically lasts up to two years, meaning short-term factors weigh less in an investment decision. Concerns about fiscal policy didn't feature in investment decisions we took in 2007.”

But what are investors to buy? If the countries of central Europe are slowly shedding their emerging market status, are their companies any longer more attractive to investors than well-managed counterparts in developed economies? Certainly, investors seem less excited by emerging Europe than by the other emerging markets. Kunal Ghosh runs a $1.2bn (€810m) quantitative emerging markets strategy for Nicholas Applegate. He says: “The Europe, Middle East and Africa region has the cheapest valuations.” While Russia is an exception – it has less exposure than the other countries of the region to the struggling west European consumer – he says the low valuations in central and eastern Europe are “to some extent justly deserved”. He explains: “As investors, we look for positive change, a forward catalyst, and we are not finding either.” With EU membership already a reality for 12 of the region's countries and reform processes that are already 20 years old, their moment of glory may have passed.

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