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What started as a correction in the US housing market has turned into a tidal wave in the leveraged financial system, engulfing everything in its path. Among the latest victims of this financial tsunami are the emerging markets of Russia, Kazakhstan and Ukraine.

Relative political stability, higher commodity prices and moderate economic growth over the past few years emboldened the region’s private corporate sector to use debt as the main source of funding for acquisitions as well as capital expenditures. In turn, domestic banks were eager to finance the burgeoning retail demand for mortgages and car loans with cheap borrowing from the international wholesale markets, making them vulnerable to external shocks.

Vulnerability of the banking system to outside forces was first observed in Kazakhstan in August 2007, as the banks rapidly expanded their loan portfolios far in excess of their deposit base, funding the gap by borrowing heavily from international banks. With the availability of credit severely curtailed in the global financial turmoil, Kazakhstani banks were forced to reduce their loan growth and deleverage. The result has been a period of painful adjustment that is likely to last for years.

Recently, the Kazakhstani government announced an injection of $5bn (£3.16bn) into the top-tier banks - matching the level of capital raised from bank shareholders - as well as the use of its accumulated foreign currency reserves to defend the local currency from further depreciation.

Ukraine, with its fragile political coalition and mounting fiscal deficit, was among the most vulnerable countries heading into the financial crisis. It is not surprising that it is one of the first and largest recipients of an IMF aid package. The recently announced loan package of $16.5bn, subject to legislative changes in Ukraine, is aimed at stabilising the currency and averting a banking crisis.

As with Kazakhstan, Ukrainian banks created a significant foreign currency mismatch by borrowing in foreign currency and lending in the local currency. The IMF package, which represents 11 per cent of Ukraine’s 2008 GDP, should give the government the time and ability to weaken the currency in an orderly fashion. Risks remain, however, as the country faces growing current account deficits due to the collapse in the price of steel, its primary export.

In contrast, Russia appeared immune earlier this year to the ravaging credit crisis due to historically high commodity prices, rampant domestic growth and significant accumulation of international reserves. However, the collapse in metal and particularly oil prices from their peak in July 2008 uncovered a number of vulnerabilities.

Although the Russian government’s debt-to-GDP ratio amounts to only 4 per cent (after a steady decline over the past decade), Russian corporate debt has been rapidly growing, reaching 43 per cent of GDP by mid-2008. The Russian banking sector and private companies also borrowed heavily from the international banks. While the overall level of indebtedness never approached that of their developed-market peers, the acceleration in debt financing was ill-timed. Faced with significant difficulties in rolling over maturing debt due to contraction of the global credit markets, Russian corporates are now reliant on help from the government and internal cashflow generation to retire their short-term foreign currency debt.

Russian equities have been significantly derated in recent months, with investors scrutinising the ability of companies to service their short-term debt while downgrading their growth prospects. As a result, the Russian market reversed its earlier outperformance and is currently one of the worst-performing markets year-to-date.

Although the primary reasons for the equity devaluations were the collapse in commodity prices and turmoil in the global financial markets, Russia contributed to the reversal with a string of missteps such as the tax investigation of a mining company, Mechel, and the ill-advised escalation of the conflict with Georgia. The market problems were further exacerbated by the Russian oligarchs, who borrowed directly from international financial institutions, using their equity stakes as collateral. As share prices plummeted on the back of global recessionary concerns, oligarchs were forced to sell down, which pushed the heavily battered equity market lower.

As the credit crunch and panic spread, the negative impact on the Russian economy worsened, with retail depositors moving assets from smaller private banks into government-backed institutions. The flight of deposits, coupled with a steep decline in overall business activity, caused several of the smaller banks to go bankrupt and to be taken over by the state. To pre-empt further economic deterioration, the government injected more than $50bn into state banks in late September to ensure adequate liquidity in the banking system. The government also set aside an additional $50bn to be injected into Vnesheconombank, Russia’s national development bank, with the mandate of extending loans directly to corporates in need of refinancing. Although these measures are sizeable, corresponding to 18 per cent of Russia’s 2008 GDP, it is too early to tell if they will be successful.

Despite these steps, the cost of credit-default swaps - financial instruments designed to protect bondholders from default - has recently spiked, implying greater than 60 per cent probability of default of the Russian sovereign-debt obligations. This is, however, highly unlikely to occur. Such probability of default has not been applied to Russian assets since 1998, and the country is now in a significantly better economic and financial position. Due to prudent financial management, Russia has accumulated substantial reserves (the third largest in the world) and set aside funds to bridge the budgetary gap during periods of depressed oil prices.

While the Russian currency is likely to depreciate over the next year with lower commodity prices, the accumulated international reserves allow the central bank to control the volatility and the extent of depreciation, a luxury it did not have in 1998. From an economic perspective, Russia finds itself in an enviable position when compared with many developed markets and will survive the current financial turmoil despite market expectations to the contrary.

Like previous crises, this one too shall pass in time. Investors can remain optimistic about the long-term prospects for the equity markets in this region and emerging markets as a whole. They continue to offer higher expected earnings growth than developed markets, and valuations are back to levels rarely seen and quite compelling for investors with longer horizons.

As bottom-up stock pickers, it is a good idea to focus on individual company fundamentals, which will drive returns over the long run. It is also wise to favour companies whose businesses are related to domestic demand and those involved with infrastructure build-out, which is critical for the region’s development. We expect these projects to proceed regardless of events in the global economy.

Emin Rasulov is portfolio manager at Batterymarch Financial Management, part of Legg Mason