THERE are now growing fears of global contagion from the US housing market collapse. Will emerging markets be able to withstand this threat? We think they can, and here's why.

First, a recap on the sub-prime crisis. Low quality US mortgage debt has been repackaged and sold on but as defaults grow in this sector, the re-packaged debt loses value. Now, banks and funds around the world are forced to re-price the debt, and realise large losses.

How this affects the real economy is through the re-pricing of debt. As US banks tighten lending requirements, debt becomes more expensive for the borrower, and harder to obtain. If this problem worsens, it could severely impact consumer confidence and curtail spending.

So far, there is no evidence that emerging market financial institutions have any meaningful exposure to debt. These repackaged sub-prime debt has only appeared in Germany, Australia and the UK. The world of proprietary trading desks, and in-house hedge funds is largely alien to emerging banking.

Direct economic contagion is also limited. The first obvious point is that emerging markets do not themselves have a sub-prime debt market, since personal finance is under-developed in these markets. Average leverage levels are very low. Many countries are now only developing mortgage markets, and have only begun lending at the higher quality end of the market.

Emerging markets also continue to improve their resilience to external shocks. On almost all measures - external and domestic balances, external debt levels, local interest  rates - emerging markets have markedly improved over the last five years.

Emerging markets now have considerable firepower to stabilise their economies in the face of external shocks. Last year was another very good year for emerging markets - and for the first time in history we can say we have seen four consecutive years of positive returns.

In our view, it is high time investors realised that they shouldn't take their cue on emerging markets from the US. Those who still see the region as the riskiest place to be in times of a US slowdown seriously need to re-examine where economic growth in the world is now coming from.

America has always been seen as the engine of global growth, but emerging markets are now running on their own engine, no longer primarily dependent on exports to developed economies to achieve their growth. Particularly so as China and India have arrived on the global economic scene.

It is estimated that growth in emerging markets as a whole accounts for some two thirds of global growth. The  BRIC (Brazil, Russia, India, China) economies by themselves account for around a third of global growth.

So, instead of being dependent on the global economy for their own growth, emerging markets are actually key drivers of the global economy.

Several economies in Asia are strong enough on their own to generate their growth, as well as to drive it elsewhere. In China, India and Malaysia, the contribution to GDP growth in the last year has been almost entirely from increasing domestic demand, rather than exports - whether to the rest of Asia or to the likes of the US and Europe.

Other countries, like the Philippines, Taiwan and Thailand, are still dependent on exports. However, they are significantly less dependent on the US as they benefit from strong trade with nearer neighbours. Emerging Asian countries' exports to China now exceed those to the US.

Importantly, China's self-sustained growth story is admittedly one driven primarily by investment spending, and not yet by the China consumer. There has been concern about whether China is actually over-spending on its own growth. We disagree. China's capital investment spending as a percentage of GDP is running at just over 40 per cent - in line with Japan in the late 1950s and 1960s, and in line with Korea and Taiwan in periods of strong growth. The level of investment spending in China is commensurate with this stage in its economic cycle.

The ability of emerging markets to sustain their own  growth is down to massive structural improvement in these economies. In the past, you knew you were investing in more volatile, weaker economies, characterised by hyper-inflation, debt crises and currency crises. That's no longer the case.

Inflation is down to single digits across the world's emerging markets, and Latin America's days of hyper-inflation are well and truly over. Most countries have seen a massive reduction in debt. The total level of government debt as a percentage of GDP (at 38 per cent) is at less than half the level of developed economies (at 89 per cent).

Overall, there are no direct financial or economic linkages from US credit problems to emerging markets. What we are left with are sentiment effects and a global increase in risk aversion - in other words, some increase in the cost of capital. No doubt there will be further headline-grabbing stories of funds realising large losses, and increased volatility in global equity markets over the next few months. Emerging markets will be buffeted by this, but they should still see strong economic growth. And with their relatively limited exposure to global credit, they should be able to avoid any drastic outcome.

Despite the strong fundamental economic case for emerging markets, there is a note of caution when it comes to equities. Share prices have risen sharply in recent weeks and valuations are beginning to look stretched, particularly in China and India. While we remain positive on the medium to longer-term prospects for emerging markets, in the near term we expect markets to be volatile and they could be vulnerable to a setback.

Allan Conway is head of emerging markets equities, and Nicholas Field, economist & strategist emerging markets, Schroders

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