Emerging Markets in Focus: Russia
ERIC FINE: Russia and the sanctions on the Russian economy comprise the biggest risks facing the EM market, in my opinion, as well as the biggest risks facing broader markets. How do I draw this conclusion? Number one: the Russian economy entered the current crisis when it was already in bad shape. It was saddled with high inflation and low growth. It's very dependent on one product – gas – that is central to the economy. Russia went into the crisis in bad shape but the one good thing you could say about Russia at the time was that the balance of payments accounts were strong. There was a current account surplus and financing was fine, meaning dollars were generally going in. Now you can't say that with the sanctions in place. Russia has a hundred billion dollars of total debt – mostly corporate debt – coming due each year and only $500 billion in reserves that are likely to be used for other things. Consequently this is a very serious risk. The one good thing you could say about Russia’s economic situation no longer holds true; the balanced payments account has also been rendered vulnerable by these sanctions. With toothless sanctions, such as the ones we've had up until a couple weeks ago, Russia hasn’t been able to issue debt. Now, however, the sanctions are growing teeth.
Risk number two is that we have, from the beginning, failed to understand where this stops. Border-wise, there are no natural division lines inside Ukraine. Let's take it bigger. Whether it's Armenia, Latvia, Moldova, or even Hungary, if this crisis escalates, parallel crises could develop in a wider range of countries. Those are the two key risks that we see with respect to Russia.
FINE: I think it's difficult for the market to position itself with respect to Russia. I think the market has generally found this challenging because Russia is a significant part of all indices. It’s a big part of the local currency bond index, a big part of the corporate dollar bond index, and it's a nontrivial part of the sovereign index. I think particularly for the huge funds, it's very challenging to respond in a way that is consistent with the fundamentals. To me, "consistent with the fundamentals" means “don't own it,” however, I think given the size of the indices, the size of Russia, and the size of some of these positions, the market is taking the stance of "underweight is a good answer for now." That’s number one. Number two: I think increasingly the market is coming on to the view that the trade doesn't make sense. This is certainly our view. We haven't had Russia exposure all year (in the funds that I manage) and our view on a trade has been that the upside-downside makes no sense. For example, Russian sovereign debt. You can get 250 basis points over treasuries for the sovereign right now and it has been selling off. The downside is that some of these bonds start trading a price basis. If you can't trade it, or if there are sanctions forcing, preventing, or reducing the risk of debt rollovers, you're in an environment in which the bonds trade on price downside. Let's use another example: Gazprom. Let's say it is 350 basis points over treasuries. You're risking 350 over and the bonds could drop 20 points this year. The upside is hard to justify. I think the market is struggling with its positioning because Gazprom had been viewed as a high-rated, low-risk name that should be in all your portfolios and now I think the market is slowly coming to the view that underweight is not the right stance given the risks and given what they mean for the upside-downside of the general Russia trade in bonds.
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