Page 91 - IFR Opportunities in Russian capital markets

CHAPTER04
ifrintelligence reports/Opportunities in: Russian Capital Markets
At the same time, unlike equities, the correlation between the performance of Russia's sovereign bonds and oil prices has been low and is getting lower as Russia's macroeconomic health continues to improve (as shown in Figure 4.12). Oil prices would have to fall to under US$38/bbl and stay there for the budget to be affected. Troika Dialog says there was no measurable correlation at all between the spread between Russia's sovereign bonds and oil prices in the last six months of 2006. This means that bond investors at least no longer see Russia as a commodity play.
Figure 4.12: Correlation between sovereign bonds and oil prices, 2000–06 (%)
60 40 20
0 -20 -40 -60
Source: Bloomberg, Troika Dialog
Six-month rolling correlation between weekly changes in Russia’s 30’s spread and weekly returns of Brent price
2000 2001
2002 2003
2004 2005 2006
Despite this progress, Russia's higher grade bonds have underperformed its emerging market peers. The Russia 30 Eurobond spread (which matures in 2030) traded within a relatively narrow range throughout 2006, and barely changed from 115bp at the end of 2005 to 112bp at the end of 2006. Likewise, the spread between the EMBI+ and EMBI+ Russia decreased by 42bp over the course of 2006 to about 83bp by the start of 2007.
Russia has been among the laggards in terms of spread performance, ahead of only Indonesia, Egypt, Turkey and South Africa in the EMBI+ universe. In total return terms, the Russia 30 gained only 3.2% in 2006, which is much less than the EMBI+ Index's return of 9.2%, and substantially behind most high-yielding names, such as Brazil (up 15.1% in 11m06).
Russian debt becomes a defensive asset
Analysts say that Russia's sovereign debt is now a defensive play, as global markets are unsettled by the changing investment environment. Russian debt fundamentals have positively affected the country's spread and although spread compression was one of the main themes of 2006, investors were still attracted by the country's shining economic fundamentals. Countries that managed to reduce their debt significantly saw their outstanding debt perform better in 2006. While countries such as Russia that have achieved substantial debt reduction did not see their spreads tightening meaningfully during the recovery following the May 2006 sell-off, the positive fundamentals mean that spreads are also unlikely to widen dramatically during a downturn in the market.
Troika Dialog analysts support this view, by arguing that Russia's beta, or correlation to interna- tional markets, has been falling in recent years, as shown in Figure 4.13.
"The beta of weekly changes in the EMBI+ Russia spread on weekly changes in the EMBI+ spread over the past six months [to the end of 2006] was only 0.44, supporting the view that Russia is a defensive asset. Russia's beta rose to 0.85 in February 2006, when emerging markets performed well, but came off during the May-June sell-off of that year and later during range-trading," the bank said in a report.
"In the context of emerging markets, Russia looks like one of the main safe havens with its strong and improving debt indicators, defensive characteristics as a recently underperforming debtor and low beta. A potential correction on commodity markets should also have little major effect on Russia's external debt, in our view," say Troika's analysts. "The Russian budget will be in surplus in 2007 even if the price of oil drops to US$37–38/bbl (Urals). Investors seem to be properly factoring this in, as the Russian spread ignored a substantial fall in oil price in the last part of 2006. In fact, there has been no correlation between changes in Russia's sovereign spread and the oil price over the last six months of 2006, which shows that investors are now looking at Russia not only as a commodity proxy. We expect this correlation to remain weak."
84