Russia set to issue first sovereign after 1998 default

It has been 12 years since Russia defaulted on its sovereign debt and a lot has changed. With market fundamentals in its favour, can Russia get it right this time?

Russia is currently on the road marketing its first sovereign bond issue since it defaulted on its debt in 1998.

At the AsianInvestor/FinanceAsia Russia Capital Raising and Investment Summit in Hong Kong this week, Ben Aris, editor-in-chief at Business New Europe, led a panel discussion about what the deal will mean for the development of the Eurobond markets and for Russia.

The country's return to the international markets, which comes amid strengthening Russian credit fundamentals, is part of the Ministry of Finance's plan to borrow about $17.8 billion from overseas.

Observers say the window for pricing is there for the taking. "Russia doesn't have any need to issue debt at the moment but it can take advantage of low interest rates," said Sergey Babayan, Russian country head at Bank of America Merrill Lynch.

"Looking at yield curves, compared to Turkey and Greece which have lower credit ratings than Russia, the yields are quite attractive for Russia to issue now," added Dmitry Dudkin, head of fixed income at Uralsib Capital.

With such strong fundamentals, observers say the bond is a marketing exercise designed to open up the Russian capital markets to the world.

Though Dudkin views the trade as a one-off event and said the Ministry of Finance is more focused on the development of the rouble market than the Eurobond market. "This will be more like the last train for investors who want to buy into the Eurobond," he said.

However, given such a long stint away from the international markets, the counter view is that in an environment where interest rates are low, a lower spread is achievable here and therefore it may be a suitable climate for Russia to set a new benchmark that can be followed by Russian corporates and banks.

Paul Forrest, director of Forrest Research, said the deal could be an exercise to deepen and widen the Russian capital markets. "After this, expect one to two issues a year to get the market rolling, coupled with issues in the rouble bond market," he said.

With rating agencies still holding Baa1/BBB ratings for Russian debt, there is a distinct possibility that the bonds may come to market undervalued.

Currently, Russian markets are very volatile and the performance is tied closely to movements in the oil price. For example, at the peak of the recent financial crisis Russia went from reporting 7% growth to an 8% contraction within a two to three month period.

Rating agencies have certainly recognised this interdependence and weigh it heavily into the sovereign rating; however the extent to which the economy is reliant on the performance of oil is debatable.

Dudkin noted that in May 2008, rating agencies underestimated how affected Russia was by the global financial crisis. It wasn't until the Ministry of Finance announced a 7% slump in GDP (the first reported decline in 10 years) that it was clear the economy was not primarily dependant on oil. In fact, it was estimated that Russia lost almost $200 billion of reserves as a result of the financial crisis.

Despite this, the country's banking system was able to weather the crisis and Russia became one of the few global economic powers that did not require government funding to bail out its financial sector.

"Last year showed the institutional strength of the economy that has been built up since 1998," said Forrest. "Russia has built the market economy in less time than it took the UK to build Wembley Stadium," he added, referring to the fact that Russia has only been operating as a market economy for the past eight years.

Based on Russia's demonstrated resilience, Dudkin and Babayan were in agreement that the economy can recover the bulk of its budget deficit by the end of this year and potentially close the year at break-even. The Ministry of Finance projects a deficit this year of 6.8% of GDP.

Realistically, in order for this to happen, specialists note that the oil price would need to hold around the $80 a barrel mark, which is an achievable target. However the Ministry of Finance is far more conservative and estimates that it will take approximately four years to return the budget to a surplus.

Babayan said the current budget is based on an oil price at $58 a barrel, despite the real price being significantly higher, and Dudkin added that the government has included expenditures in the budget that will most likely not be spent, for example, the recapitalisation of banks. If anything, the overly conservative budget is viewed as a politically driven move to ensure that the proposed 2011 budget, which is currently going through parliament, is approved.

Despite the politics and the issues surrounding the budget deficit, Russia's economic standing is much better than that of recent sovereign issuers to the Eurobond market, such as Greece and Turkey. Together with the rarity of the deal, this should help the bond to perform well. At the same time, the scarcity value is expected to result in a good pricing for the borrower.

Investor talks have been arranged in London, Singapore and Germany by Barclays, Citi, Credit Suisse and VTB Capital. Russia analysts expect that, once the roadshow ends on April 21, execution will be swift and well received by a market that has been waiting for Russian debt for over a decade.

¬ Haymarket Media Limited. All rights reserved.
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