Page 97 - IFR Opportunities in Russian capital markets

CHAPTER04
ifrintelligence reports/Opportunities in: Russian Capital Markets
Currency liberalisation
After the 1998 financial crisis, the CBR imposed a strict regime of currency controls as it tried to rebuild its reserves. Exporters were forced to sell the majority of their repatriated dollar earnings, while foreign investors unfortunate enough to be holding Russian debt at the time of the default saw their money frozen in special S- accounts which they could not touch.
Over the next eight years these controls have gradually been lifted as the CBR's hard currency reserves were quickly replenished by soaring oil prices. The process was completed on 1 July 2006, when the last of the currency controls was lifted and the ruble became a fully convertible currency – six months earlier than originally planned.
The current ‘Law on Currency Regulation and Control’ empowers the monetary authorities to regulate the flow of capital by ordering a freeze on part of sums entering or leaving Russia, and the CBR has made wide use of these powers since 2004.
Liberalisation of the currency market will, in the long term, affect many areas of the Russian economy. Its greatest effect, though, will be on the ruble debt market, particularly state debt.
Following the financial crisis of 1998, the monetary authorities assumed tight controls on capital entering the fixed income market. If the corporate debt market is now fairly free from constraints, the sovereign debt market has, until very recently, been very heavily regulated. Between 1999 and 2004, non-residents were barred from investing new funds in OFZs. The introduction of S-accounts provided access again to this market, but part of any funds invested has still had to lie in reserve with the CBR for 12 months without any interest accruing. The proportion was initially set at 20% of the total investment (3% for investments in corporate and municipal paper). In 2005 the rate was reduced to 15%, and then 7.5% (for non-state debt, it was reduced to 2% and then 1%).
Foreign investors are still very wary of Russia's financial markets. Many ruled out entirely the possibility of investing in OFZs, while the reservation system was still in force. Since the abolition of all restrictions on 1 July 2006, foreign investors' attention has thus naturally drifted towards sovereign debt.
Foreign capital made up around 12–14% of the corporate and municipal debt markets by the start of 2007, and around 5% of the OFZ market, even accounting for investment by foreign bank subsidiaries registered in Russia, which will likely be the main source of interest in the next few years.
The balance has also been tipped towards state debt over the previous benchmark, the City of Moscow bonds, after the capital reduced the number of its primary placements in 2005 since the city budget was in surplus. This was the case, too, in 2006 and Moscow began to actively buy back short-term paper in both 2005 and 2006. Although volumes of this debt did grow, the rate of growth lagged far behind market demand. Hence, many turned their gaze back to OFZs, the natural base market which had lost its benchmark status after the 1998 crisis.
Corporate Eurobonds
Gazprombank was the first to issue a Eurobond after the 1998 crisis, but other Russian blue chips were quick to follow. The Eurobond market is almost double that of local bonds outstanding, with more than 90% denominated in US dollars, and also provides access to a much wider and more diversified investor base.
At the same time, the amount of corporate Eurobonds exceeded outstanding sovereign issues for the first time in 2006, largely driven by the insatiable appetite for capital of the Russian financial sector issuers (see Figure 4.19). In all, Russian corporate issuers raised about US$25bn in Eurobonds and credit-linked notes (CLNs) on the international markets in 2006.
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