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. Last Updated: 07/27/2016

The New Face of Russian Debt

The year 1996 has been an annus mirabilis for Russian debt. The holders of tsarist bonds will see the return of their money after 70 years, and Russia has raised a bumper $1 billion Eurobond loan. Ben Hooson reports on an incredible turnaround


If you owe the bank $1,000, you have a problem; if you owe the bank $1 million, the bank has a problem. Imagine, then, the mood of foreign bankers and lender governments at the end of 1991, when the Soviet Union disappeared off the face of the earth and left debts worth over $70 billion.


The sinking feeling on international markets in 1991 was aggravated by the knowledge that Russia was doing it to them for the second time.


When the Bolsheviks took power in 1917, Lenin had refused any responsibility for the accrued debts of Imperial Russia, which had become the largest debtor in the world. The French, who had lent the equivalent of $30 billion in today's money for the modernization of the Russian empire, were left holding stacks of tsarist bonds that became worthless overnight. Optimists bequeathed them to their children. Pessimists used them to wallpaper their baths.


Yet the incredible news of 1996 is that Russia has now come in from the cold. It still has debts of $120 billion. But despite its two-time loser reputation, it is respectable.


After Soviet default in 1991 and humiliating indecision in 1992 on the question of whether Russia or the other former Soviet republics were liable for the debt of a defunct nation, Russia has come to agreements with all its creditors.


Moreover, it has proven itself a reliable enough risk to raise an incredible $1 billion of new debt on world markets with a bumper Eurobond issue last month.


Prime Minister Viktor Chernomyrdin's announcement of a deal with France's tsarist bondholders is almost the final rite of passage for Russia in its road out of the wilderness.


The heirs to the original holders, many of whom had long since given up hope, will now at long last see some payback. Chernomyrdin offered them a $400 million settlement in Paris last week -- only 0.2 percent of their total claim.


The new byword is, "Russia pays its debts."


Economists are hailing this return to financial respectability as a major plus for the whole economy. It is a sign that Russia has recovered from the Soviet collapse and developed the basic financial systems and self-confidence needed to borrow on world markets.


"The success of this [Eurobond] placement means that the Russians will be able to cover a significant part of their budget deficit with more Eurobond issues," said Roland Nash, economist with the investment bank Renaissance Capital. "It is a quantum leap which could be enough to kick-start growth."





What persuaded international investors, ranging from South Korean banks to U.S. mutual fund managers, to snap up the Eurobond and start taking Russia seriously?


For those watching the market, the turnaround has been coming for some time and those who knew what to look for have made huge profits.


Most importantly, over the past year, Russia has accepted full responsibility and worked out long-term rescheduling for most of the $100 billion of Soviet debt and interest that it owed to governments, foreign banks and foreign companies.


The easiest part of the rescheduling occurred in April, when Russia reached an agreement on the repayment schedule for $40 billion of mostly Soviet debt to other governments, members of the Paris Club of creditor nations.


If all goes according to plan, the Paris Club debt -- and interest on it -- will be paid off in installments from 2002 to 2020.


Russia's handling of its debt to the Paris Club of creditors has always been a political issue -- since the Paris group of creditors are governments, the IOUs never changed hands on the world's money markets.


But Russia has also won the confidence of another crucial group known as the London Club, a group of private banks owed $33 billion of Soviet debt. The deal is not inked but Russia is now close to reaching an understanding with these creditors as well.


"There have been several deals with the London Club since 1991 that didn't come off, but this time people are happy about final rescheduling being in place by the end of the first quarter next year," said Michael Jordan, debt specialist with the Bank of America in London.


The last big financial factor behind Russia's Eurobond success was the more than satisfactory credit ratings, BB and BB-, awarded to the country at the end of October by the top U.S. credit rating agencies, Moody's and Standard & Poor's. The agencies' assessments may fall short of so-called investment grade, which would be an invitation to buy the country's debt instruments, but professional money lenders know how to read between the lines.


"The agencies could not have given investment-grade ratings, even if they wanted to, because the 1991 default is too recent and the London Club hasn't actually closed yet, even if it looks a sure thing," said Jordan.


The financial progress was underpinned by this year's big events on the political scene. The Communists were seen off in the summer presidential elections, and the surgeon's knife looks like it has put President Boris Yeltsin back on track for his second term.


International lenders still have their doubts, but they sense that Russia could be an opportunity they should not miss.


"People make comparisons with Brazil, because both are mineral rich, with large potential for a booming economy," said Jordan. "But the difference is that Russia has high-quality mass education, it's in the G-8, maybe it's a superpower."


The improvement in Russia's international financial standing has produced huge profits for some traders. The debts of the London Club, called Vnesh debt in honor of the Soviet External Trade Bank through which it was originally channelled, has never left the limelight in the world's financial centers. Vnesh paper, as it is called, has always been for sale.


The London debt has been traded on the world's fixed-income markets since before 1991, and the growing certainty of payment has made it the star performer of this year on those markets. Its value has shot from 33 cents to over 78 cents on the dollar since January.


Before its sharp crescendo this year, the value of Vnesh paper had bounced up and down according to waxing or waning expectations of a settlement between the Russian government and the London Club.


In fact, since no formal agreement yet exists on the bonds, traders have been speculating in the hope of a deal. Addicts of Russian debt have to make do with a special instrument called "when and if" Vnesh. This trades like the real thing, but with the caveat that all deals are annulled if the London Club debt is not conclusively rescheduled by Dec. 31, 1997.


It now looks likely that Russia will reach a deal on the London Club Vnesh debt roughly similar to the one reached with the Paris Club. Settlement will be over the next 25 years, with a grace period until 2002. In a sign that Russia is serious about paying, deals in actual Vnesh paper were temporarily halted in August this year when the Russians invited holders of the IOUs to submit them for verification.


When (and if) the rescheduling is completed, the temporary instrument is exchanged for new bonds, issued by the Russian government, representing the $25.5 billion of principal and $7.5 billion of interest which constitutes the London debt. The arrangement should ensure a seamless continuation of Vnesh trading right through the complex rescheduling deal.


Vnesh (London Club) debt has been the hottest property in Russian hard-currency debt, owing to its size and good performance, but if there was a prize for being talked about, it would undoubtedly go to another Russian hard-currency instrument -- the $10 billion of Finance Ministry bonds or, for short, MinFins.


Five tranches of MinFins with various redemption dates were issued in 1993 to Russian enterprises and joint ventures as compensation for frozen accounts in the defunct Soviet Foreign Trade Bank. Since then, a further two tranches have been issued, not as compensation but as a placement for cash. The actual MinFins are prohibited from leaving Russia, but most of the trade in these instruments has now found its way to Western fixed-income markets.


But the system of trading MinFin bonds was deeply flawed. This year several foreign banks with significant MinFin holdings had an unpleasant surprise when Russian authorities announced the arrest of bonds which had allegedly been stolen at some point in their commercial career. About $30 million worth were arrested in June and a further $56 million worth were recently seized.


The trouble is that the government had no way of keeping track of who owned the bonds. Foreigners could trade the title to bonds stored in a bank vault, only to discover later that the bonds they had been trading had been stolen much earlier.


For a while, it was unclear whether foreigners who had bought stolen bonds would be refunded. But Deputy Prime Minister for the Economy Vladimir Potanin decided in November not to risk spoiling the country's Eurobond issue, and ordered the unfreezing of most of the controversial MinFins.


The government is now planning an electronic system that minimizes the risk of physical theft of the bonds. Andrei Yashenko of United City Bank estimated that 90 percent of MinFin bonds are already safe in the vaults of state-owned Vneshtorgbank, avoiding the risk that arises when they are deposited with smaller regional banks or kept by their owners.


A London debt specialist called MinFins "a strange pocket of domestic dollar debt," and judged that their troubled history would discourage the Russians from issuing more. Vnesh is plentiful, but not liable to multiply.





The Russian dollar debt instrument of the future is undoubtedly the Eurobond.


The November success will enable the Russian government to issue far more Eurobonds in 1997 than the $1.3 billion which are written into the budget.


But the big question is -- who else in Russia will be allowed to issue Eurobonds? Anyone who wants to tap this market must pass through the narrow gate of the Finance Ministry.


"The Finance Ministry and the Central Bank have a policy of not allowing any issues which would interfere with federal borrowing on the Eurobond market," said Vladimir Dmitriyev, deputy head of the ministry's foreign credits department.


At least it seems certain that the city of Moscow will go ahead with its issue, expected to collect $500 million in the first quarter of 1996.


"There will be a worldwide road show and the issue will mark the start of a serious debt program for the city," said George Nianias, managing director of Denholm Hall, the company which is advising the Moscow authorities on the Eurobond project.


There is disagreement among analysts about whether the lion's share of the Eurobond market will go to Russian regions and municipalities or to Russian companies, such as LUKoil. But there are some good reasons why the government will be likely to give more support to the former than the latter.


Most of all, there is the point that cities must cover their deficits and will borrow from Russians if they cannot get permission for a Eurobond. That would mean less domestic money for the domestic treasury-bill market, which the government cannot do without.


"Those considerations give the Finance Ministry an interest in letting Russian cities go abroad for funding, although the ministry will be wary of a default by a city, because that would undermine federal borrowing," said Nash of Renaissance Capital.


A source closely involved in the November Eurobond launch said that the Russians had shown "impeccable judgement" in their handling of the deal, and she would be surprised if they made the elementary mistake of over-milking the market.


"Some people are worried about a feeding frenzy of Russian mandates," she said. "But the Russians know that you cannot flood the market -- you have to develop the yield curve."


Vneshekonombank (London Club) debt $33 billion


Soviet debt to foreign banks





Internal Hard-currency Loan Bonds (OVVZ) $10 billion


Also called Vebovki, MinFins


Dollar bonds, with a coupon, issued in seven tranches. Redemption dates from 1999 to 2011





Soviet debt to foreign companies $4 billion


Currently trades at 60 cents to the dollar





Russian Eurobond $1 billion


Issued November 1996; five-year maturity, 10.25 percent interest





Soviet Eurobond 100 million Swiss francs


($77 million)


Eurobonds issued by the Soviet government in the 1980s. One issue remains in circulation, due for redemption in 1998