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. Last Updated: 07/27/2016

T-Bill Negotiations Stall Over 'The Asset Question'

With representatives of the foreign holders of Russian domestic debt due Wednesday in Moscow for talks, Finance Ministry officials seem determined to tease and frustrate the 19 banks to which they owe about $4 billion.

Russia has finally expressed a willingness to let the creditors get their hands on some worthwhile assets - in the form of corporate shares - in return for the millions they invested in now worthless state paper.

However, while this week's proposal looks like a major change of heart, the fine print makes it as unpalatable as previous government schemes, analysts said.

The gridlock threatens to delay the actual implementation of debt restructuring, which the government had hoped to launch by the second half of this month and complete by mid-March. One report even surfaced Tuesday saying that "the asset question" could prevent a solution from being reached.

"For the time being, the list of investment opportunities is insufficient for accepting a final decision," Mikhail Kasyanov, deputy finance minister, said Tuesday.

The current scheme would allow foreigners to buy corporate equity on the domestic market using one-third of their cash allotment under the current restructuring package. That would amount to 3.3 percent of the banks' holdings of government treasury bills, or GKOs, on which Russia defaulted on Aug. 17. In monetary terms, that would represent about $100 million.

However, the deal is both frustrating and meaningless for the foreign banks, analysts said.

"This is an outrageous example of false generosity," said Eric Kraus, head of fixed-income analysis at Dresdner Kleinwort Benson. Foreigners have scoffed at the idea since they could move to buy corporate shares with their cash allotment without the government's say-so.

While foreign creditors have been insisting on the equity option, they want to be able to purchase corporate stocks with funds from the other parts of the restructuring deal, not with the cash portion.

Under an agreement reached by the two sides at the end of November, Russia's 83 billion ruble ($4 billion) domestic debt to foreigners is to be restructured in three parts: 10 percent in three cash payments, 20 percent in zero-coupon bonds with three-year maturity, and 70 percent in four- and five-year bonds with a decreasing 30 percent coupon. The main sticking point is the 20 percent. Foreign banks want to use these zero-coupon bonds for swaps into corporate equity, whereas the government has been consistently proposing that foreign investors use these bonds to buy shares in banks or to pay off tax liabilities.

While Russian officials have pushed the latter options time and again, they hold no attraction for the Western investors.

As most foreigners have no tax liabilities, and bank shares are, in the worlds of one analyst, "as good as worthless," the government's scheme would leave nonresidents with securities that had no inherent value. But officials keep pushing these proposals because the government fears that, if it allows them to buy shares with the zero-coupon bonds, the foreigners will simply dump the shares within months of buying them and then whisk their money out of the country.

The issue is crucial since the government is insisting that a majority of the money paid out on the defaulted debt be "locked-in," or left in Russia, a tenet with which foreigners basically agree. Both sides recognize that the Central Bank lacks the foreign reserves to withstand a major flight to the dollar.

"What the government should do is to make [the deal] attractive as a lock-in," said Kraus at Dresdner Kleinwort Benson. The government needs to find ways for ruble investment in Russia, he said, which would have the added benefit of keeping foreigners interested in the country's growth.

As it stands, analysts are claiming that the current deal would give foreigners 3 to 4 cents for every dollar invested in the GKO-OFZ market. This is an unacceptable level, bankers are saying.

"They are not showing a good faith effort to give foreigners something for their money," said Kraus. "This deal is confiscatory."

For foreign investors, buying into equity is clearly the best alternative. First, keeping rubles in a bank account exposes investors to devaluation risk. Most foreign economists at this point are predicting a significant devaluation of the ruble in 1999, so the dollar value of those rubles which investors receive will gradually erode.

Second, buying into equities would be a wise strategic investment move considering the extraordinary low prices of Russian shares. Not only would investors get a hedge against inflation and devaluation, but they could potentially win back some of their losses through a slight market recovery.

So far most foreign banks have built their portfolios of Russian equity through offshore accounts. An added bonus to an increased equity plan would be to bring some of these banks into Russia, not to mention giving a powerful thrust to the dormant domestic stock market.

Russia's total GKO debt stands at 240 billion rubles - worth $40 billion before the Aug. 17 ruble devaluation, but only $12 billion now - of which foreigners are estimated to hold 30 percent.