Two Debt Markets Diverge on Eve of Election

Ten days before the presidential election, Russia's two sovereign debt markets are taking markedly different paths -- one riding a pre-poll swell of foreign support, the other mired in domestic stagnation.

Old Soviet debt inherited by Russia, called Vnesh bonds, has been active primarily due to foreign investors optimistic of a win by President Boris Yeltsin, with activity somewhat mirroring the recent bull run in the stock market. But the market for Ministry of Finance bonds, or MinFins, has remained flat, analysts said.

"It hasn't been as pronounced as the equities side, but it has been positively affected," Philip Poole, ING Barings head of fixed income and equity research for Eastern Europe, said about Vnesh debt. "There's been nothing discernible from the elections on the MinFin market."

Vnesh paper was hardly changed Thursday after dominating world debt markets the day before, when it rose 3/8 of a point to 44 percent of face value -- almost a point rise from the week before, Reuters reported.

"I can't say there's been dramatic reaction, but there's been cautious strength," said Eric Fine, Russia debt analyst for Morgan Stanley in New York. "A lot of it's elections and just getting them over with."

Vnesh debt's low this year was 27.8 cents on the dollar, but it picked up steam with March's International Monetary Fund deal, and April's Paris Club deal rescheduling $40 billion in inherited Soviet debt pushed prices over 40 cents.

The market has been unfazed by a delayed term sheet that is expected to finalize negotiations to refinance $25 billion in debt owed to the London Club of commercial creditors. "I would characterize those more as procedural issues," Fine said.

However, the MinFin paper -- held by large percentages of both foreign and domestic investors -- has remained quiet, with analysts attributing the sluggishness to a variety of factors.

Yields on the five outstanding MinFin tranches, with maturities from 1999 to 2011, have budged little in recent months, bracketed in a trading range from 15 to 20 percent of face value.

"I think the reason it's quiet is Russians are not investing in Russia before the elections. Period," said Thomas Reed, director of fixed income for Alliance-Menatep. "Foreigners are not by themselves going to drive prices on MinFins that much."Other market players said that even though foreign interest in MinFins has grown dramatically in the past six months, it is limited due to the fact that other emerging debt markets, such as Brady Bonds of Latin America, have greater liquidity. Also, issues surrounding settlement remain a concern.

"A lot of the Western playing is based more on the banks themselves and not as much on the client base," said one trader who asked not to be identified.

Analysts also said that two new tranches issued by the government three weeks ago and valued at $3.5 billion have yet to trickle down to the secondary market from the Russian enterprises to which the dollar-denominated bonds are issued as a means of paying off debt.

Outstanding MinFin debt grew during the May 14 auction from about $7 billion to $9.6 billion.

Despite the lethargic market, Morgan Stanley recommended in a report last month that investors look at both Vnesh and MinFin paper, a position Fine emphasized. A current Vnesh price of about 44 could jump to 49 after the elections and continue climbing.

"One concern is, there could be a strong showing by Zyuganov in the first round that could shake things up and create a better buying opportunity," Fine said. "But as Yeltsin's victory becomes apparent, I think there should be a dramatic reaction from the dollar-denominated, fixed-income instruments.

"Certainly, MinFins and Vnesh have a lot more to go," he said.