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. Last Updated: 07/27/2016

Stability Sours Debt Swapping Deals

'Even though yields have fallen, they're still attractive.'

Julian Mayo

Renewed investor confidence in Russia's ability to pay its debts may have the perverse effect of making it tougher for the country to solve its financial woes.

Investors are shunning an offer to exchange high-yielding ruble treasury bills for longer-dated dollar-denominated bonds, a move that would significantly reduce the government's debt-service costs and help it balance its budget.

On July 13, the International Monetary Fund and other lenders pledged $22.6 billion this year and next to bolster Russian reserves, easing concern Russia might default on weekly debt payments of more than $1 billion, or devalue the ruble.

"The reason rates were high is the devaluation risk, and the IMF money means that's eliminated,'' said Simon Treacher, who owns bills as part of the $1.5 billion he helps manage for Morgan Grenfell Asset Management in London. "Why would you switch? I'd rather let them mature and take the high yield.''

The government is offering a minimum of $2 billion of seven- and 20-year dollar bonds, either for cash or in exchange for ruble-denominated bills. Bill yields rose to more than 120 percent in recent days, but news of the IMF-led loan deal has cut those yields in half to about 60 percent.

Investors said that the present yields still beat the likely yield on the new dollar debt, which will be set at a premium to U.S. government bonds and isn't expected to be much above the 14.26 percent yield on existing Russian dollar bonds payable in 2007.

"Even though yields have fallen, they are very attractive,'' said Julian Mayo, head of corporate finance at Regent Pacific in London, with about $1 billion invested in Russia. "The valuation levels even now still clearly imply a great degree of currency or repayment risk, but those risks have been largely eliminated'' by the IMF loan. Russia's domestic debt burden until the end of 1999 is about $60 billion, while its foreign debt for the same period is about $18 billion. The voluntary swap applies to bills that mature before July 1, 1999.

Russia is taking bids on the new dollar bonds until Friday, with results slated for next week. Investors bidding for the bonds specify the minimum yield they'll accept. They can also leave it to the government to suggest a premium.

Deputy Finance Minister Mikhail Kasyanov said the debt swap is a one-time event and Russia could exchange much more than the $2 billion worth of GKOs, as Russian T-bills are known, it said it would exchange for dollar bonds. "Although it's premature to say, we have no limitations in mind at the moment,'' he said, adding that between Aug. 1 and Jan. 1, 1999, Russia has to repay $24 billion worth of GKOs. Between January and June 1999, it must repay $17 billion worth of GKOs.

Sergei Stankovski, an executive director for fixed income at Goldman Sachs International in London, which is managing the exchange offer, urged investors to support the swap.

"The major concern is the ability of the Finance Ministry to service short-term debt,'' Stankovski said. "There is a risk that if people do not exchange, this rally won't continue and everything will collapse again.''

Bella Zlatkis, head of the Russian Finance Ministry's securities department, said she expects 20 percent to 30 percent of the 256 billion rubles ($41.2 billion) of outstanding bills eligible for the exchange offer to be swapped.

Mayo at Regent Pacific said investors may be willing to trade their bills for bonds if they "want to lower their risk profile.''