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“Siluanov called out Sberbank and VTB last year for failing to bid in OFZ bond auctions and on three occasions this quarter auctions ended unsuccessfully due to a lack of bids. Bond issuance this quarter has fallen sharply and an auction this week was called off amid “market volatility”. Lower appetite to hold sovereign debt likely reflects the growing share of bonds issued at fixed rather than floating rate this year as well as banks ramping up private sector lending. These shifts in the supply of and demand for OFZs have raised the term premium embedded in Russia’s sovereign bond yields,” says Peach.
Corporate lending continued to grow quickly in April, up 1.9% y/y with developers accounting for around a third of the increase as project financing for residential construction, the CBR said in its latest banking sector update. The feel-good rising real incomes coupled with a state subsidies mortgage programme have been fuelling the apartment buying boom in Russia’s real estate sector. Around three quarters of mortgage loans issued in April were issued as part of the government programmes, the CBR said.
The feel-good real income rise is also driving a surge in consumer borrowing, mostly by using credit cards, that is also worrying the CBR, which has increased the macroprudential limits on retail loans to try and head off a credit bubble forming.
However, both these trends are a growing vulnerability which will be very painful if the military Keynesianism growth music stops playing and Russia’s economy contracts sharply.
In the meantime, falling demand for bonds has forced MinFin to hike yields from around 7% per-war to around 18% now, making domestic borrowing increasingly expensive.
The government’s looser fiscal stance has also heightened inflation and interest rate expectations. Core inflation strengthened in April, and the central bank announced that the "disinflation trend came to an end" last month. Policymakers have hinted at further interest rate hikes, with the latest weekly inflation figures pointing to month-on-month annualised inflation exceeding 6% this month, against the central bank's 4% target.
The central bank argues that Russia’s economy can handle high interest rates and that the surge in yields should not threaten financial stability. And as the prime rate is some nine
Russia Ministry of Finance Bond Placements & Proposals (RUBbn per Quarter)
percentage points higher than inflation, real wages are growing strongly fuelling a consumption boom that is further heating the economy but pleasing the population.
Debt securities account for 11% of banks’ assets, according to Capital Economics, with a significant portion being floating rate OFZs, whose prices have increased this year. The central bank estimates unrealised losses as of April at 0.8% of bank capital, a manageable level.
Despite the broader financial system's resilience, higher private sector debt servicing costs may adversely affect highly leveraged households and corporates with weak balance sheets. Nevertheless, the risks to financial stability appear limited, with good lending quality, low household debt ratios, and a large share of corporate and mortgage borrowing under preferential government programmes.
“Around three quarters of mortgage loans issued in April were issued as part of the government programmes”
“The broader and perhaps more important point is that the situation in Russia – in which the government ramps up state spending and the central bank is forced to tighten monetary policy ever further in response – is becoming unsustainable. We argued that this was likely in a Focus in mid-2023. Large debt issuance will put further upward pressure on government bond yields and we now think another central bank interest rate hike looks likely next week, with a 200bp increase to 18.00% not out of the question,” says Peach.
The growing risk is that loose fiscal policy could lead to tighter monetary conditions, potentially causing a sharp economic slowdown. Interest rates might become prohibitively expensive for the private sector, and financial repression policies may force state banks to reduce private sector lending to absorb higher bond issuance.
Russia 2y LCU Bond Yield (%)
Source: Russia Ministry of Finance, Capital Economics
Source: Refinitiv, Capital Economics
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