When the Russian central bank raised interest rates by 6.5% to a dramatic 17.0% in the early hours of Tuesday morning, the price of its Russian bonds plummeted. There were a few winners and many losers in the volatility that followed, but few lost as heavily as Pimco’s emerging markets bond fund. Twenty one percent of its total assets (which have fallen from $1.5 billion to $496 million due to losses and investor flight) were exposed to Russia, mostly in corporate bonds. As a result, the fund has lost 9.0% of its value this month, underperforming 95% of its peers.
Pimco’s emerging markets fund is just one portfolio investor, however, and Russia just one country. For executives at multinational who invest directly in the market, the Russian economy’s descent to currency and outright financial crisis has broader implications.
PIMCO is only one investor
In a low interest rate environment, investors sought higher yields by moving their money to emerging markets. For example, the biggest energy companies in some of the biggest emerging markets have sold billions of dollars of higher-yield bonds to investors eager to capitalize on relatively higher interest rates. As oil prices fell and emerging markets appear more financially vulnerable, companies like Gazprom in Russia, Pemex in Mexico, and Petrobas in Brazil were hit the hardest. Gazprom’s yields spiked to 9.9% from 6.0%, Petrobas’ to 7.6% from 5.0%, and Pemex to 4.8% from 4.0%.
PIMCO’s predicament is thus only one example of what is happening to investors holding emerging markets’ corporate and sovereign debt – they’re losing a lot of money.
Russia is only one country
Russia’s currency crisis is currently out in front other emerging markets. However, other markets are beginning to catch Russia’s cold. While financial market volatility in countries like Turkey, Nigeria, and Brazil may not be as pronounced, their governments and their companies have issued large amounts of short-term debt at low rates in the past several years. This leaves them vulnerable to the same reality that Russia now faces: capital can flow out when you need it most. While the problem is localized mainly in Russia, we expect some degree of contagion as investors see what has happened to Pimco and more broadly in Russia, they will pull capital back to safer markets, even at lower yields. The implosion of a major bond fund could accelerate contagion, similar to what happened when Long Term Capital Management imploded as a result of the 1998 crisis.
Countries with high total and short-term debt are most likely to face a liquidity crisis
What it means for multinationals
We have seen this movie before. Investors are losing money, and Russia is only the first in a list of countries susceptible to a crisis. Executives can anticipate more capital to return to the United States, increasing dollar strength and keeping interest rates low in the US longer than expected. In emerging markets, a strengthening dollar will force governments to choose between devalued currencies or high interest rates. Emerging markets competition will thus be in a weak position to export and to finance debt, opening the door to acquisition by MNCs. Actions for companies should be:
- Review recent history: In 1998, Russia’s crash prompted a global selloff, but large gains were realized in the aftermath. Position your company to be a winner this time around
- Stress-test your market prioritization assumptions. In which markets do governments and corporations carry large amounts of short term debt? These are the markets that have the highest risk of contagion
- Create upside contingency plans. Leverage the strong dollar and low interest rates to get ahead of competitors and benefit from opportunities to establish local manufacturing or in-house distribution via acquisition
FSG Client Resources:
- Log into FSG’s Data Explorer to schedule monthly alerts to track energy price and country and currency forecast revisions
- Read Monthly Market Monitors on FSG’s client portal to follow developments in sovereign and corporate debt yields what they mean for the business environment
- Not a client? Contact us to learn more.