Russia Redeems Itself to The West

Russia is scheduled for redemption Tuesday.

That is when the government has ordered its foreign finance agent, Vneshekonombank, to make good on the nation's first sovereign bond since the days of the tsars.

By paying off in full, and on time, the $1 billion it borrowed in 1996 in the form of a five-year Eurobond, analysts say Russia will move further into the good graces of the international investment community, which was badly burned in the crisis of 1998.

In the wake of the economic collapse that August, Russia defaulted on nearly every obligation it had. Tens of billions of dollars owed to foreign creditors were restructured, and efforts to restructure tens of billions more continue. Russia is even being sued for bonds issued before the 1917 Revolution.

For the government, however, Eurobonds have always been a sacred cow -- the standard of international creditworthiness. Even in the tempestuous months following the crisis, when many were expecting a default, Russia continued to service its dollar-denominated Eurobonds, which now total 11.

Now Russia is going to be rewarded.

Analysts say the repayment of the bond is bound to be followed by upgrades to Russia's sovereign rating by international agencies, which will further boost other Russian debt markets and make it easier and cheaper for the government to borrow.

Hardly anyone in the market doubted the 2001 Eurobond would be redeemed, but "there is a difference between an expectation and a fact," said James Fenkner, chief economist at Troika Dialog investment bank. "A birthday doesn't make you older, but it's a cause for celebration; it's a date," he said.

Demand for Russian debt, especially sovereign bonds, has been growing steadily for the past few months.

In August, for the first time since the crisis, Russian Eurobonds outperformed the emerging market benchmark index, EMBI+.

"Until September the market was depressed, although it was still growing, but then it was like a dam bursting," said NIKoil fixed income analyst Sergei Konstantinov, adding that $1.44 billion "has reportedly poured into the [Russian] Eurobond market in the past two weeks" and a comparable amount has been injected for the past few months.

"It's a very positive statement that Russia is able to make the payment without the need to refinance the debt, there are not many countries which pay down a $1 billion bond without coming back into the market immediately to refinance it," said ING Barings economist Philip Poole. "[Redeeming the debt] will stand out in this somewhat difficult credit environment, which is the result of concerns about global growth and the impact of September 11th on markets generally," Poole said.

"As people get paid back they will be looking to reinvest the money into the Russian curve," he added.

Analysts are reluctant to predict how soon rating agencies may raise Russia's sovereign ratings. Some have said that they may go up almost immediately after Tuesday's payment, while others expect a decision in weeks or months.

"In our opinion, Russia is still at least one notch underrated," said Poole.

Fenkner noted that Russia's rating by Standard & Poor's, currently "B," is two notches lower than it was when the bond was issued five years ago (BB-). "This is a significant mismatch," Fenkner said. "I would be surprised if the rating doesn't get upgraded to 'B+' or even 'BB-' by the end of the year," he said.

Analysts also expect Russia's weight to increase in emerging market indices on the back of the Eurobond repayment.

One worry, however, is that Russia's ongoing feud with OPEC, which has caused considerable instability in the price of oil, Russia's main hard currency export, may stall rating agencies.

"We may be a bit of price softness in the short term, but generally there's a firm tone to the market even despite the hiccup with OPEC," said Letitia Rydjeski, an analyst with Aton.

Konstantinov said the market has already factored in the oil dispute.

The growing trust in Russian Eurobonds also bodes well for other debt instruments.

Sub-sovereign borrowers have enjoyed increasing demand for their debt. The city of Moscow, which redeemed its two remaining Eurobond issues this year, was able to place a total of 700 million euros over the past two months. Moscow may have been in a rush to issue new debt this year because of the Finance Ministry freeze on foreign borrowing effective, in Moscow's case, Jan. 1. The ban, imposed earlier this year, affects all the regions except St. Petersburg, which has to refinance a Eurobond issue maturing in 2002. However, the ministry has been sending signals lately that the ban may be partially lifted.

Rydjeski said the corporate debt market is still too small for analysts to perceive a definite trend. However, regarding corporate Eurobonds, he said: "We hope to see a takeoff in 2002."

And the future for ruble-denominated corporate bonds also looks promising.

"Negative interest rates and the absence of a banking sector have catalyzed a fledgling corporate debt market," Renaissance Capital said.