A recent surge in demand for Russian credit appears on course to continue into the last quarter of 2016, as yield-hungry foreign investors continue to explore emerging markets with superior rate premiums.
The Russian sovereign set the stage with a VTB Capital-led 10-year Eurobond issuance on September 22nd that helped raise US$1.25bn with a 3.99% yield. It followed the finance ministry’s tentative move in May to tap international bond markets with US$1.75bn worth of securities, with investor demand reaching as high as US$7bn.
The initial offering was delayed as clearing houses weighed up the risks and possible effects of sanctions on the security, but was eventually settled in by Euroclear and Clearstream in July. The positive outcome boosted the price of the bonds and opened the doors for other public and private borrowers to follow suit.
“The initial issuance in May carried significant risk, which was reflected in the delayed clearance, and largely left investors cold,” explained Yury Tulinov, head of research at Rosbank. “But tapping the bond markets in September, Russia’s finance ministry displayed astute judgement of the situation, offering attractive terms to yield-hungry global investors.”
Return to the bond markets
Even if the first offering was seen more as a symbolic gesture by Western observers, it appears to have produced the desired effect, demonstrating to private and financial entities in Russia that international markets are open to their debt.
As a result, shortly after the sovereign tap a number of state-owned and private entities, including property giant O1 Properties, Russian Railways (RZD) and Global Ports Investments Plc tapped the international debt markets, collectively raising around US$2.5bn. Russian Railway’s recent US$500m Eurobond oversold by a factor of 8, prompting the state transportation giant to prepare for its first rouble-denominated Eurobond issuance in 2 years.
More recently, Otkritie bank continued the trend with a US$400m unsecured 3-year bond, while another FI, Promsvyazbank, is gearing up to roadshow a 3.5-year dollar bond, overseen by HSBC, ING, JP Morgan and Renaissance Capital.
“While it is difficult to predict who if any would follow RZD and Otkritie with another issuance, the bigger picture suggests that the Eurobond market is wide open for Russian companies,” Tulinov noted.
“The markets reacted to evolving expectations of a Fed rate hike and rising oil prices – all creating conditions for tapering the external market for Russian government and top-tier borrowers,” added Dmitry Polevoy, chief economist, Russia & CIS at ING. “Sanctions are no longer a significant issue as in the low/zero interest rate environment Russian risk is in high demand due to a combination of relatively high yields and understandable risk profile.”
For investors, the concerns traditionally associated with Russia, namely the rouble’s volatility and low oil prices, have been alleviated in recent months. The rouble has settled into the lower 60s range, after going up to a record high of 82.45 against the dollar in January. The ongoing political stand-off with the US and Europe adds a premium on any Russian bonds, but while geopolitical tensions continued throughout the year, they haven’t really destabilised the country politically or economically.
Recovery on the horizon
Russia’s GDP decline throughout 2016 will amount to 1.2% - a notable improvement over the previously predicted 1.9% drop in GDP. The World Bank expects the country’s GDP to rise by 1.5% next year and by 1.8% in 2018.
There have previously been concerns about the health of the country’s banking sector, resulting in efforts to consolidate it. Over 200 banks had their licences revoked as part of a Central Bank-led health check, which is expected to take another 4 or 5 years to complete. But the banking system is still very top-heavy, with the top 6 FIs holding 69% of the sector's RUB81tn ($1.25 trillion) in assets.
Capital flows from the finance ministry's budget deficit spending have allowed banks to wean themselves off Central Bank’s money, but with this comes a risks of inflation, excessive lending and, potentially, asset bubbles.
There have not been any long-term problems with local or hard currency liquidity in the sector, at least for the big borrowers. The demand for international capital is rather driven by a desire to maintain a consistent presence in the investment space and a steady cash flow.
“It is worth pointing out that only two Russian banks issued so far, so I wouldn’t draw any far-reaching conclusions at this stage,” Tulinov said.
“Local liquidity has been sufficient since 2H15,” reaffirmed Polevoy, “but lately there was some reduction of FX deposits in the banking sector as a reaction to higher RRR on FX liabilities from the Central Bank. Also, banks have been cutting deposit rates on FX accounts, which could have also affected it.”
These woes have not manifested into a longer-term problem for now, but some observers warn that the Central Bank’s involvement in planned privatisation deals could lead to a serious currency shortage.
In particular, the privatisation of Rosneft through an unusual scheme of the company buying out its own stake from the government, could lead to a significant outflow of currency from Russian banks and could trigger dollar shortages.
“Based on our estimates, a large share of Rosneft’s available funds is held in local banks. Balances in the state banks accounted for at least US$5.2bn – the amount, that will leave the market,” warned Raiffeisenbank. “Regardless of which currency the deal is paid for, it could cause a hard currency ‘famine’”.
But for the time being, the consensus among investors is that there are few real internal risks to Russia’s stability and investment potential. Global threats - such as a hard landing in China, US Fed rate hikes and the weak performance of the Eurozone – remain in the background, but pose no unique and immediate risk.
“We agree with the view that Russia might be more resilient now as the active deleveraging after sanctions helped to improve the debt profile of many companies,” Polevoy concludes.