Local currency government and corporate bonds have attracted an unprecedented following.

Traditionally, emerging market governments have offered local debt in local currency but have needed to borrow in dollars, at higher interest rates, to entice foreign investors.

Now, however, habitually conservative mutual and pension funds have joined more speculative hedge funds and private banks in investing in local currency-denominated debt.

Last year saw landmark issues in pesos and reals by the Colombian government and a Brazilian bank, respectively. According to third quarter data complied by industry association Emta, trading of local instruments, at $700bn concentrated in Brazil, Mexico, Poland, Turkey and South Africa, outpaced traditional foreign ones.

Although they face administrative and tax difficulties, investors have been enticed by price appreciation, higher yields and strengthening institutional and legal frameworks.

The International Monetary Fund estimates the size of local currency markets to be about $4,000bn, several times that of outstanding Brady and global bonds. Local currency debt has seen strong growth in Asian crisis countries seeking to fund bank and corporate recapitalisation, and in Europe and Latin America to cover fiscal deficits while meeting the allocation needs of growing private pension funds.

Trading in emerging currencies, onshore and off, now accounts for almost 10 per cent of the $1,900bn daily total. Local currency bonds have also been made more attractive by the wide availability of foreign exchange derivatives to hedge risk.

In Latin America, Brazil and Mexico are the most popular plays. Both have sophisticated futures and options exchanges and currency products listed on the New York and Chicago Mercantile exchanges. Mexican authorities have fashioned a yield curve out to 30 years that includes asset-backed alternatives such as mortgage bonds.

In Brazil, double-digit returns and active management by Brazilian mutual funds have supported the debt markets - so much so that non-residents currently control 10 per cent of the government market, according to Brazil's central bank. The foreigners built their large stake in spite of a 10 per cent withholding tax and complex administrative structures.

In Argentina, bodens - bonds offered after the 2001 default - are a preferred asset for dedicated money managers who must keep a stake in the country regardless of its external default. Chile, with its pioneer compulsory private pension scheme, investment grade rating and active currency hedging market has also garnered attention. And in Colombia, restrictions imposed last year on short-term money flows were in part the result of high demand for its short-term government bonds.

In emerging Europe, the Czech Republic, Hungary and Poland have all adopted European Union standard practices regarding bond issuance and since the foundation of domestic markets in the late 1990s foreigners have retained an average 40 per cent share. Poland, the largest of the new EU members, has been a perennial favourite. Of the non-EU countries, Turkey has been embraced by specialist convergence and macro-style hedge funds interested in its mix of declining inflation and interest rates, a strengthening and redenominated lira, GDP growth, and a recent nod toward future EU entry.

In Asia various factors including restricted access, low yields and regular foreign exchange intervention have limited overseas appetite.

But Thailand is backing a push to spur local market activity across the region. The Asean +3 nations have launched a $2bn fund, which will appoint outside managers and may eventually list sub-funds on exchanges throughout Asia.

Elsewhere, South Africa is a prime destination, with the rand benefiting from buoyant gold and mineral exports and elaborate bond and derivatives capacity providing ample liquidity. With central bank rate cuts pushing bond yields to high single digits, higher-yielding corporate bonds have started to attract demand. Neighbours such as Botswana are also in discussions about using South African exchanges.

Retail investors seeking cost-effective direct exposure in this area have few public vehicles beyond dedicated hedge funds. There is also no specific index to guide strategy and track performance. However, conventional global emerging debt funds may have small positions in local currency paper, and central Europe and Mexican markets are in standard worldwide indices grouping both developed and emerging economies.

Growing investor interest in the sector is being addressed. JP Morgan's Emerging Local Markets Index may be updated to reflect the new industry search for a benchmark, and the World Bank's IFC arm may resurrect an effort to establish a local bond index modeled after its original ones for equities. Individual investors can also look in the coming months for large Wall Street and London debt houses to introduce yardsticks to accompany expected fund launches.

With the long overdue dollar decline and a likely interruption in the multi-year rally in emerging market external debt, local currency fixed income, which briefly enjoyed attention a decade ago, has finally come into its own as a lasting mainstream allocation alternative.

The writer is senior partner of Kleiman International Partners