Page 88 - IFR Opportunities in Russian capital markets

CHAPTER04
ifrintelligence reports/Opportunities in: Russian Capital Markets
Sovereign Eurobonds
Russia's sovereign Eurobonds have rapidly gained in creditably over the last eight years, but as the government is unlikely to issue more Eurobonds in 2007 or 2008 the sovereign Eurobond market is on the verge of extinction.
Eurobonds were the only instrument that the government did not default on during the 1998 financial crisis, but servicing of the bonds was suspended for five years and in the first years the bonds were traded at a very deep discount.
However, since about 2000, the spread between the yields on Russia's Eurobonds and the benchmark US T-bills has rapidly converged as Russia's macroeconomic fortunes have improved.
Russia's Eurobonds enjoyed a re-rating in the middle of 2005, as the spread between them and US T-bills fell from about 280bp in the summer of 2004 to 130bp by the end of August 2005, and was in a trading band of between 95bp and 135bp for most of 2006, where it is now expected to stay.
The Yukos fracas spooked portfolio investors, but largely passed the bond market by, which was more focused on Russia’s outstanding macroeconomic results and the upgrade to investment grade by the three major ratings agencies at the start of 2005.
This episode was a classic example of the mixed picture that is painted for Russia-watchers, as equity investors ran for the hills while bond traders were opening the champagne.
Investors into Russia's sovereign bonds were attracted by the double-plus of high yields in an otherwise lacklustre global market and ruble appreciation. Brokers report that the enthusiasm for Russian bonds means that foreigners are diving into the uncharted waters of second and third-tier junk bonds, but even in these risky investments yields are down below 11% – slightly less than inflation.
Although Russia's sovereign Eurobonds are now seen as rock solid investments, thanks to the more than US$300bn the state has in reserves, the government is unlikely to issue any more debt for the time being and has been paying down what debt it has.
In 2006, the state paid off most of its debt to the Paris Club of commercial creditors early and further reduced the amount of sovereign debt.
With the small and dwindling supply, investors have turned their attention to bonds from the state-owned companies as quasi-sovereign bonds, which have also seen their spreads over
US T-bills fall dramatically in the last two years or so.
Figure 4.9: Outstanding federal bonds (OFZ vs GSB, traded vs non-traded), 2006–08F (US$bn)
US$bn US$bn 60 60
50 50 40 40 30 30 20 20 10 10
00 2006 2007 2008F
OFZ GSB
Source: Minfin, Cbonds, ING estimates
Paris club redemptions
2006
2007 2008F Traded Non-traded
Modern Russia started life taking over the debt of the Soviet Union, not just for Russia but all the countries that now make up the CIS. Most of this debt was owed to the so-called Paris Club of commercial debtors and much of it was the non-tradable type of debt. This meant that there was no market mechanism available to clear the debt, which had to be settled through bilateral negotiations.
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