After piling up trillions of dollars in sovereign wealth funds and whetting the appetite of Western brokers, developing nations could now be forced to rethink strategies and tap this rainy-day capital for their own shaky domestic markets.
Emerging market governments have for several years amassed huge foreign exchange reserves via export growth and currency targeting policies. And many have created state-owned wealth managing vehicles in order to diversify and optimise the investment of these windfalls for future generations.
With over $3 trillion, sovereign wealth funds (SWFs) have to date directed the majority of their investments into developed markets, spending some $80 billion to buy stakes in major banks since 2007.
However, there is a risk their attention may soon shift back to domestic markets to aid local financial systems as months of foreign capital flight have seen many of these markets buckle under the weight of a rising dollar and ebbing commodity prices.
Emerging stocks, measured by MSCI, have lost a third of their value this year. As domestic financial systems come under pressure, the temptation to turn to these sovereign funds to support additional fiscal spending or to provide liquidity for the banking sector will grow.
In Russia, where stocks have fallen more than 40 percent this year, Finance Minister Alexei Kudrin on Thursday said the country's two wealth funds, totalling around $175 billion, could be used to support financial markets in the future.
"The strength that these wealth funds provide for the countries is that they can be called upon in times of needs - in times of fiscal and external pressures," said Ben Faulks, associate director at Standard & Poor's.
"They provide a significant buffer for future fiscal shocks. They are also there for future generations. The idea is that in time they generate sufficient revenue to meet all government spending needs."
The MSCI emerging stocks index hit a 22-month low this week, on track to underperform broader world equities on an annual basis for the first time since 2000.
The August Merrill Lynch survey showed one in four fund managers said they would underweight emerging markets in the next 12 months. Reflecting investor aversion to risky markets, yields on emerging sovereign debt have risen to a three-year high around 330 basis points over US Treasuries.
"The slowdown in global demand will severely hit these nations who have benefited from the boom in the past years. They are spending FX reserves to support the economy. SWFs will effectively do the same thing," said Simon Derrick, head of FX strategy at Bank of New York Mellon.
"If you have problems with the local economy draining out of foreign investment, it makes sense to replace or counterbalance that with your domestic funds." State-owned wealth funds, mainly from commodity-producing emerging nations, have become a key provider of liquidity as the one-year-old credit crunch hit banks, funds and private equity.
Assets managed by SWFs are widely estimated to grow to $12 trillion by 2015, but a rising dollar and falling commodity prices mean they might not grow that much. Fourteen of 20 largest SWFs have commodities as their main source of income, State Street said.
The pace of reserve accumulation is certainly slowing in many emerging economies, also because governments are drawing on their savings, which would reduce the extra capital that will be transferred to wealth funds.
"The decline in commodity prices will see a significant slowdown in the pace of reserve accumulation. It should also mean a sharp slowdown in the pace of money being put into SWFs simply because less money is coming in," Derrick said.
Russia's gold and currency reserves, the world's third largest, fell to a two-month low of $573.6 billion in the latest week. The central bank has intervened in the market to buy the rouble currency since early August, with dealers estimating it sold around $18 billion.
Moreover, Finance Minister Kudrin has said the country will spend all of its wealth funds by 2027 as the share of windfall revenues from energy exports declines. He has also proposed that part of the wealth funds be used to fund a pension deficit or meet fiscal spending plans.
Russia's benchmark stock index has fallen more than 40 percent this year. In China, whose wealth fund has assets of $200 billion, stock markets are even falling faster. The country's main stock index lost more than 60 percent since January.
"We may not be far away from the government stepping in to support the equity market via direct stock purchases... as is also being speculated in China," Nick Chamie, head of emerging market research at RBC Dominion Securities, said in a note to clients.
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