Bondholder Feels ‘Warm Joy Inside’ as Russia Parries Blows

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The suffering consumer is no reason for investors to grumble at the Russian government’s handling of a currency collapse and the aftermath, according to emerging markets fund Ashmore Group Plc.

“I bleed for the poor Russian consumers who are suddenly facing this terrible macro-adjustment, but as a bondholder I feel warm joy inside because I have just been shown a government that takes its responsibilities to its creditors extremely seriously,” Jan Dehn, head of research at Ashmore, which manages about $60 billion in emerging-market assets, said in an interview in London on Thursday.

That’s a far cry from 1998, when the Russian government defaulted on $40 billion of domestic debt, the bulk of which was held by foreign investors. The default triggered the collapse of Long-Term Capital Management LP, one of the world’s largest hedge funds at the time, and inflicted losses on some of the world’s largest banks.

This time, buoyed by approval ratings in excess of 80 percent amid a standoff with the U.S. and Europe over Ukraine, President Vladimir Putin is letting households bear the brunt of the blowback from the ruble’s collapse and a tailspin in oil prices that sent shockwaves across the economy. With the currency in a near freefall, authorities shifted to a free-floating exchange rate ahead of schedule in November, which “completely protected” public finances from the crash in oil prices, according to Dehn.

‘Relatively Light’

After riding the roller-coaster of Russian markets in the past year, Ashmore’s holdings are now “relatively light” on the government’s ruble bonds and underweight its dollar debt, Dehn said.

“The next upside for Russian bonds is when the sanctions get relieved and that’s not immediately,” he said. “The Russia sovereign trade is now behind us, but there is quite a lot of value in quasi sovereigns and corporates.”

Investors who’ve stuck with Russia this far have been rewarded with 29 percent returns on the country’s local-currency debt this year, the most in the Bloomberg Emerging Market Local Sovereign Index, as the ruble rallied to the best performance globally against the dollar in the first six months of the year.

‘Some Praise’

“Russia deserves some praise because first of all it was very well prepared,” Dehn said. “The way they prepared the bond market, their floating exchange rate, their commitment not to do capital controls and building big reserves -- they were well prepared for shocks.”

With economic performance deteriorating and inflation slowing, Dehn sees an opening for the central bank to proceed with interest-rate cuts in the coming months. He predicts up to 300 basis points more of monetary easing this year, more than all but three of the 27 economists surveyed by Bloomberg.

That would bring the benchmark to the lowest since October, reversing the central bank’s emergency rate increase to 17 percent seven months ago. The Bank of Russia has already cut its key rate by a cumulative 5.5 percentage points in four steps this year to 11.5 percent.

Clueless Market

By the end of the year, “you will start seeing the economy bottoming out and you will see inflation falling very aggressively,” Dehn said. “The market is probably being a little bit too pessimistic about the falling inflation and about the central bank’s forecast for inflation. I think the central bank is going to be right: they’ve shown that they know what they are doing and the market has shown it doesn’t know what it’s doing.”

Price growth remains more than threefold the central bank’s mid-term target of 4 percent. Inflation, which eased for a third month in June to 15.3 percent from a year earlier, will slow below 7 percent next June, the Bank of Russia forecasts. Dehn says inflation will be at 7 percent to 8 percent by year-end.

Policy makers will cut the key rate to 11 percent at their July 31 meeting, according to the median of 27 estimates in a Bloomberg survey.

“I am betting on the central bank and I think they will be right,” Dehn said. “I think they will be right on inflation, I think they will be right on rate cuts.”

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