Page 90 - IFR Opportunities in Russian capital markets

CHAPTER04
ifrintelligence reports/Opportunities in: Russian Capital Markets
Aries bonds
Russia's decision to redeem the Paris Club debt early faced one obstacle. In 2004, the German government was facing a budget crisis and, strapped for cash, repackaged some Russia's debt to the Paris Club into so-called Aries bonds. This effectively locked up part of Germany's share of Russia's debt to the Paris Club.
The bonds were not very successful. They were issued with a 200bp spread over Russia's sovereign bonds, but this spread disappeared by the second half of 2005 and was negative by 2006.
During negotiations in 2005 on redemption of the first part of Russia's Paris Club debt, the German government rejected outright any possibility of the debt locked in Aries bonds being included in the deal, suggesting that Russia would not be able to pay down its Paris Club debt in full. At end-2005, however, Gerhard Schroeder was replaced as chancellor by Angela Merkel, who had not been involved in the Aries deal. The new German authorities were ready to compromise. Counterparties reached an agreement on a premium, the Aries bond was shifted from Russian to German debt and Russia was able to redeem the debt in full.
Spread performance
International investors’ decreasing aversion to risk, as low global interest rates made bond investors hungry for returns, looms large over the spread between Russian sovereign and quasi- sovereign bonds and the benchmark US T-bills. However, while spreads narrowed to under 100bp, Russia’s bonds have preformed less well than the bonds of many of its emerging market peers.
As a class, emerging market bonds boasted a positive performance in 2006, with the spread of the EMBI+ (the Emerging Markets Bond Index Plus), the widely accepted proxy for emerging markets as a whole, tightening from 245bp at end 2005 to 198bp by December 2006.
Most of the tightening had occurred by early May 2006, though when emerging equity and fixed income markets were both in the spotlight during a global sell-off, the EMBI+ spread was already at an all-time low of 175bp. In the wake of the equity markets sell-off, the emerging market bonds spread increased by over 50bp. Although they did tighten again, they have been range-bound since and have failed to return to pre-sell-off record low levels (see Figure 4.11).
Figure 4.11: EMBI+ spread, 2006 (bp)
260 240 220 200 180 160
EMBI+ spread, bps
Source: Bloomberg
Jan 06
Mar 06
May 06
Jul 06
Sep 06
Nov 06
The tightening of Russia bonds against US T-bills has been driven by the sparkling macroeconom- ic results, the growing pile of cash in the CBR's coffers and the Kremlin's policy of paying
down debt early.
Influences on spread compression
Meanwhile, external factors contributing to the tightening of spreads were mainly driven by international investors’ growing appetite for risk (or blatant disregard for risk, depending on your standpoint) and the general growth in credibility of the whole emerging market story. These markets, after half a decade of strong growth, are increasingly becoming ‘emerged’ markets; Russia's hat-trick of investment grade ratings won in 2005 is testament to the improving stability of the market.
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