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. Last Updated: 07/27/2016

Hefty Sovereign Bond Poses Big Risks


Russia’s plan to issue sovereign eurobonds next year to pave the way for new corporate international borrowing could backfire if it issues as much as $20 billion, pushing up risk premiums for all borrowers.
The extra cash will come in handy for a government facing at least three years of budget deficits, including almost $100 billion in 2009, as tax revenues fall and it keeps spending high to help Russia out of a recession.
By creating a more liquid and attractively priced sovereign bond to act as a benchmark, officials also hope to make it easier for companies to return to the foreign market post-credit crunch and refinance their hefty debts.
The country is set to double domestic issuance to 1.3 trillion rubles ($42 billion) next year, as well as issue its first eurobond since 2000. Officials have estimated future foreign borrowing at $10 billion a year, but reports suggest that it could be as high as $20 billion.
“It could prove hard. Global investors are likely to demand a decent risk premium. … No doubt that such issues are likely to put upward pressure on interest rates and downward pressure on the ruble,” said Lars Rasmussen, analyst at Danske Bank.
With outstanding sovereign foreign debt at just 2 percent of gross domestic product, the country has plenty of scope to borrow more. But the size of the issue is huge by the scale of emerging markets, where by far the biggest annual placement in the last three years was $5.7 billion from Turkey in 2006.
Analysts at Troika Dialog estimated that Russia could place up to $7 billion abroad without any negative consequences, while any greater amount could push up yields and steal investor demand away from the Russian corporate eurobond market.
Sergei Bolshakov, investment analyst at Argo Capital Management, which manages $500 million globally, agrees that the premium would rise if the size is big.
“People might look at Brazil and Turkey as the closest comparables,” he added. Turkey placed a 10-year, $1.5 billion eurobond at 7.5 percent in April, while Brazil placed $750 million of 10-year paper in May at 5.8 percent.
Although Russia’s state debt is low, bond investors are sensitive to risk from some $440 billion in corporate debt.
Russia’s five-year credit default swaps — the cost of insuring against a possible sovereign default — reflect this, trading at 305 basis points compared with Turkey’s 231 and Brazil’s 160, meaning that it costs $305,000 a year over five years to insure $10 million in Russian debt.
“They’ve not been in the market for a long time, they would need to work on their investor relations,” said Tim Ash, analyst at RBS.
Russia’s benchmark 2030 eurobond currently yields about 7.5 percent.
Domestic issuance plans could also prove hard to put into practice — the ruble debt market has been damaged by currency depreciation, a wave of defaults from small companies swallowed up by recession and the flight of foreign investors.
Inflation running at 12 percent year on year is also a stumbling block, and although recent months have brought signs of a cautious revival the Finance Ministry has so far placed about 160 billion rubles out of a planned 530 billion rubles for 2009.
ING said the domestic plans “currently look unrealistic,” while Troika estimated that up to 500 billion rubles could be issued at home without hurting the market.
One boon for Russia could be the Urals oil price. If it significantly exceeds the $55 a barrel factored into next year’s budget, there will be less need to borrow — both at home and abroad — and at the same time investors will be keener to put cash into the resource-focused economy.
Even now, demand for Russian paper clearly exists, as illustrated by a heavily oversubscribed issue from state gas export monopoly Gazprom, but $20 billion would still be hard to swallow at a good price.
“That’s a huge amount; even half that is actually quite a lot,” said Ash at RBS.