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Why foreign-currency debt is best for Russia

A troubled government that swaps domestic debt for foreign currency-denominated debt would seem to be inviting catastrophe - isn't that what dumped Asia in the mire? But Russia has done exactly that. Alex Jurshevski argues that this and other measures are just what Russia needs.

The burning question for many emerging markets investors is: "What will happen next in Russia?" Looking at past emerging markets crises for answers provides both good news and bad. The good news is that following what is usually a painful adjustment process, countries that have experienced financial dislocation typically emerge to regain economic competitiveness. Ultimately investor confidence is restored and the countries regain rating agencies' approval. Unfortunately the good news pretty much ends there.

The history of past emerging markets crises provides grim detail of what usually happens during the downturn:

  • risk premia typically reach extremely high levels and the yield curve becomes steeply inverse, market volatility increases and the currency comes under pressure. Judging from past experience (as shown in the table), these phenomena can persist for years. Russia's interest rate risk premia are presently huge;

  • the large numbers of foreign direct and portfolio investors that pour money into the markets in search of "high" local yields before the onset of a crisis have an uneasy relationship with the local economy. If foreign portfolio and/or direct investors panic, the risk of severe exchange rate and interest rate pressures increases significantly;

  • credit ratings typically remain under downward pressure until well after the crisis has passed.

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