Emerging Europe has stepped back from the abyss. For a region relying heavily on capital inflows made scarce by the global financial crisis the worst could be expected. And indeed, several economies have suffered a great deal and had to rely on help from their friends. But global risk appetite has returned and the global recession seems to be bottoming out. Does this mean that strong growth and renewed convergence will return naturally to emerging Europe?

Not necessarily. Just as hopes of decoupling from the epicenter of the crisis were dashed, so will the notion that all emerging economies will automatically recover alongside the advanced economies. Surely, some bounceback will occur, as trade has started to resume. But it is already noticeable that the downturn is lingering longer in a number of emerging market economies. Why? Many of these countries were severely impacted by the slowdown in portfolio inflows and the reduction in credit by troubled cross-border banks deleveraging their balance sheets. As capital flows have started to resume, much more differentiation is taking place as investors are more keen to scrutinize external and internal vulnerabilities.

This change in investor attitude has caused a dramatic shift in market risks. As the global factors that drove both risks and attitudes to unprecedented levels recede, domestic factors and policies surface as reasons for investors to differentiate among countries. On the top of their list of worries seem to be the state of private balance sheets and the financial system, as well as the closely related issue of fiscal sustainability. The result is that investors demand higher risk premiums, slowing down the recovery in the region.

But investors' newfound scrutiny is also a chance to get rewarded for sound policies. In fact, countries with better policies fared much better already during th