Russia made a sparkling return to international credit markets with its first sovereign Eurobond issue in 12 years to raise a total of $5.5bn - the second biggest dollar issue on record.
What a difference a decade makes! The Russian government was forced to default on its international debt in the wake of the financial crisis that swept the country in the summer of 1998, costing international holders of its bonds some $40bn in losses.
However, investors were champing at the bid to get a piece of the action this time round with the offer at least three times oversubscribed with record low yields for a Russian bond.
On April 22, Russia sold $2 bn worth of five-year bonds and $3.5 bn in 10-year bonds.
In terms of pricing, the five-year portion pays a coupon of 3.625 pc and spread of 125 basis points over US Treasuries, while the 10-year tranche pays a 5 pc coupon and spread of 135 basis points over Treasuries.
The world has been turned upside down by the crisis. While Greece is sagging under heavy public debt, Russia not only has almost no debt to speak off (Capital Economics predict 9.5 pc of GDP by the end of this year), but also has well over $400 bn in hard currency reserves. That’s five times more than either the USA or Britain, making it the third richest country in the world in terms of cash.
While Greece will struggle to pay off its bonds as it staggers under a 12 pc budget deficit, Russia has $24 in cash to cover each dollar the government plans to borrow.
Russia is enjoying a mirror image of the problems its more developed peers are facing. For example, Britain is one of the most indebted countries in Europe after it borrowed a massive $245.8 bn last year, ratcheting up its debt against reserves. America is in similar dire straights.
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| Credit default swaps measure the market's interest in bond insurance. The higher the number, the more likely the country – as viewed by the global market – is to default |
Nonetheless, Russia’s pubic finances are still under pressure. It needs to finance a budget deficit that will come in-between 3 pc and 8 pc (depending on the price of oil) and needs to raise funds to get it through this lean patch.
Russia’s finance officials are planning a tour of Asia, Europe and America to promote Russia’s first Eurobond sale since 1998 – 12 years after it defaulted on its bonds during its last big crisis – and they are confident that they will be able to tap the markets for relatively cheap money.
“Borrowing terms will likely be very advantageous,” finance minister Alexei Kudrin told reporters earlier this month. The market understands that Russia is able to borrow domestically if the terms aren’t, “extremely favourable”.
“Kudrin is right to be confident,” says Liam Halligan, chief economist with Prosperity Capital Management. “Since taking office in May 2000, he has built a massive reserve base and paid off almost all sovereign debts. Russia is launching this Eurobond as one of the world’s most fiscally secure nations – a reality likely to cause mainstream Western investors to reassess a range of Russian assets.”
Kudrin has the authority to borrow upto $17.8 bn, but as oil prices breached the $85 per barrel level at the start of April, money is starting to pour into the country and most experts expect Russia to borrow half or even a quarter of this amount.
The price of the bond will highlight the overly cautious stance of most rating agencies on Russia. Currently, Russian sovereign debt has a BBB rating, which is only three notches above junk-bond status. At the same time, the US and Britain have (so far) kept their AAA ratings, despite their worsening situations.
Most economists are predicting Europe’s external debt to rise from 100 pc of GDP to 130 pc over the next five years, while that of Russia is expected to start falling. Analysts say that the ratings of developed countries have disconnected with reality, while countries such as Russia are being penalised.
“On the basis of our model, the [best possible] AAA rating for the US and Britain cannot be explained, as these two countries are rated two to three rating notches better than countries with comparable fundamental data,” Ingo Jungwirth, an analyst with Raiffeisen International wrote in a study in March.
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| The price/earnings ratio
measures a company’s stock value against its earnings.
The lower the ratio, the better value a stock is seen to be |
This study found that, based on the country’s finances, both the USA and Britain should be downgraded three notches to a simple AA. However, if the ratings agencies actually went through with a downgrade, the cost of borrowing to both countries would spike, sparking a financial crisis that could wreck the global economy for decades. Jungwirth suggests that these two countries earn a “bonus” for being too big to fail.
On the flip side, Russia is underrated given the strength of its financial position. Consider that on the day Iceland defaulted on its debt at the start of this crisis it enjoyed higher ratings than Russia. Today, Russia’s BAA1 rating from Moody’s is still the same as bailout-dependent Iceland’s. Fitch and Standard & Poor’s currently class Russian debt as BBB – even lower than Moody’s.
“These ratings seriously understate Russia’s ability to service and repay its debts,” says Mr Halligan. “Some say they reflect the risk that Russia might ‘choose to default’.
“Yet Russia’s political elite was traumatised by 1998; Kudrin, with the blessing of successive premiers, has spent 10 years trying to rebuild his country’s fiscal reputation. The idea of a deliberate default is absurd.”
There are already signs that investors are cottoning onto the strength of the Russian bond offering. After US investment bank Lehman Brothers collapsed, the spreads on British credit defaults swaps – a kind of insurance against bond defaults by the issuer – have soared by 281 pc.
“The government isn’t issuing the bond to raise money. It already has plenty of money,” says Mr Halligan. “The main reason they are issuing the bond is to draw attention to the Russian economy, force the government to explain its reform agenda better and help ‘decontaminate’ Russia as a place to do business.”
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