Obviously, Brazil worries that if its currency continues to appreciate, export-driven businesses will find it difficult to compete. The other concern is that if conditions turn for the worse, investors will scramble to pull their money out of the economy, sending it into free-fall, as happened with many of the Asian economies in 1997.

Perhaps the most important determinant of Brazil’s market and currency is the rate of US Treasuries and Chinese interest rates. With the carry-trade funding so much of Brazil’s recent economic ascent, even a mild uptick in US interest rates could cause significant movements out of Brazilian equities, debt, and the real. As long as it’s cheap to borrow in the US and domestic returns are low, Brazil will continue to soak up a lot of portfolio investment. It is, in many ways, the star of the rush to the BRICs and other emerging-markets – more fully developed and less exposed to geopolitical instability than India, possessed of similar resources and better-governed than Russia, and far more transparent than China.

Despite this, their fates are intertwined – China and Brazil are particularly inextricable, since the latter supplies many of the raw materials for the former’s infrastructure projects. Recent signals that China would trim capital spending and raise rates sent the value of Brazilian assets plummeting along with the real.

Nouriel Roubini has identified a “global carry trade” in emerging market assets. Short-term interest rates in the developed world hover around 0%. Investors, in the US, for instance, are seeking returns that they can’t find domestically. For the past 8 or 9 months, they essentially borrowed for free at home and then bought commodities, emerging market stocks and bonds, and anything else that promised a decent return. The upside has been huge surges in foreign assets; the BOVESPA, Brazil’s main stock index, has doubled since the depths of the crisis in March.

If any doubt remained about Brazil’s new prominence on the financial landscape, it was likely swept away by two pieces of news in the past year. The first was Brazil’s offer to loan almost $10 bn to the IMF. Recall that in 2002, the IMF prepared a $30 bn loan in case the ascension of leftist President Luiz Inacio da Silva somehow caused financial chaos or capital flight. For Brazil, a serial debtor frequently afflicted in the past with crippling inflation, loaning to the IMF is a big step into the room with the world’s economic heavy hitters.

A recent piece of news is the revelation that Citibank approached Brazil during the deepest part of the global meltdown and asked the Brazilian government to buy as much as 30% of the company. The news that Brazil received this offer – and declined it – has shocked quite a few observers around the world.

Did Citi’s directors prefer the political implications of being bought by a foreign government to receiving more federal aid from the US? Do they have more faith in the hands on the tiller in Brasilia than those in private equity? Or were they simply desperate and out of options?

Whatever the reason, Brazil is definitely on track to emerge from its developing nation status. Even its recent protectionism seems to be receding. Brazil’s Minister of Finance, Guido Mantega announced that Brazil was done – for now – with its currency and investment controls. This amounts to an admission of defeat, or at the very least a stalemate. Either the measures proved ineffective at stemming the flow of money into the country, or the government fears that excessive interference with the financial industry will break the nation’s carefully rebuilt reputation for fiscal responsibility and liberalization. It is a sign of the times in Brazil that Henrique Meirelles, Governor of the Central Bank, is dropping hints about a presidential bid in the next election. He would likely take on the centrist Governor of Sao Paulo Jose Serra, and Lula’s hand-picked successor and electoral favorite, Chief of Staff Dilma Roussef.

Brazil’s outlook is generally positive, but the recent correction downwards is not entirely unfounded. Overall, however, it is the best-positioned of the emerging market nations to scramble on to the center of the global economic stage. With the 2014 World Cup and the 2016 Olympics in the pipeline, eyes will be on Brazil for a while yet.

When I started trading emerging market sovereign debt in the early 1980s, the big risk was non-payment. The danger of default always loomed over a deal. It was like buying a Japanese car or a transistor radio made in Taiwan in the early 1970s: cheap, substandard goods that would likely fail early and often. However, some countries we still label “emerging markets” have become economic powerhouses: China, India, Brazil and Russia for example, holding foreign exchange reserves respectively of $2,300 billion, $284 billion, $235 billion and $433 billion.

Today, more than $5 billion of emerging market debt (EMD) is traded daily and prices are sky high in both debt and equities. Since Jan. 1, 2009 the MSCI Total Return Emerging Markets Index is up 65.1%, outperforming the S&P 500 Total Return Index, which is up 17%.

Read on…

MarketFolly.com also featured my overview of the EMD market.