Putin Bond Demand Sinks as Russia Drought Lifts Prices

Russia sold the smallest amount of 2014 ruble bonds in more than two months as investors demanded higher yields after the worst drought in 50 years boosted food prices.

The Ministry of Finance raised 1.2 billion rubles ($40 million), or 6 percent, of the 20 billion rubles of federal debt known as OFZs offered yesterday, the least since a June 2 auction, according to central bank data. The notes due in November 2014 were priced to yield 6.92 percent, matching market rates for the bonds, according to data compiled by Bloomberg.

The government needs to offer at least 10 basis points, or 0.10 percentage point, more to make the bonds attractive, according to Russian lenders Bank Zenit and IFC Metropol. Citigroup Inc.’s Eugene Belin said he won’t buy OFZs that mature in more than two years as faster price increases threaten to push borrowing costs higher. Prices for grains, beans and pulses rose 3.9 percent last month, the biggest monthly jump since May 2008, according to the state’s statistics service.

“The demand is low, interest for government bonds has fallen and therefore the market participants that are still left are trying to bid at higher yields,” said Alexander Ovchinnikov, a vice-president of global markets in Moscow at Troika Dialog, Russia’s oldest investment bank. “Obviously it does not suit the Ministry of Finance.”

Russia, the world’s third-largest wheat grower in the 2009- 2010 season, began a temporary ban on grain exports, including wheat, from Aug. 15 as the drought cut the country’s crop by 38 percent, according to government forecasts.

Food Prices

Food accounts for 38 percent of the Russian consumer price index, according to Moscow-based Alfa Bank. Food makes up 16 percent of the U.S. measure, according to data compiled by Bloomberg.

Inflation concerns may have deterred investors from buying OFZs this week, Deputy Finance Minister Dmitry Pankin said in a telephone interview from Moscow. “It is clear that expectations of somewhat stronger inflation tendencies are having an effect,” he said.

A 10 percentage-point rise in food prices would boost Russian inflation by 3.2 percentage points, said Moscow-based Citigroup economist Natalia Novikova, who predicts inflation will average 7 percent by year-end. The government forecasts inflation may climb to as much as 6.5 percent this year, from a record low of 5.5 percent in July.

Inflation Bottoms

“We’ve seen just a temporary bottom” in inflation, Belin, Citigroup’s head of fixed income in Moscow, said in a phone interview. “That’s making people more cautious on the long end” of the country’s OFZ debt, he said.

Russia also sold 18.6 billion rubles of OFZs due Aug. 2012 at yesterday’s auction, after offering 20 billion rubles.

The ruble gained 0.2 percent to 30.3700 per dollar yesterday, the strongest since Aug. 11. The currency has weakened 0.3 percent this year. Non-deliverable forwards show the ruble at 30.6138 per dollar in three months, a decline of 0.8 percent.

The yield on Russia’s dollar bonds due in 2020 fell 3 basis points to 4.57 percent yesterday, a record low.

The cost of protecting Russian debt against non-payment for five years using credit-default swaps rose 0.5 basis point to 160 yesterday, according to data provider CMA. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.

Russia credit-default swaps cost 3 basis points less than contracts for Turkey, which is rated four levels lower at Ba2 by Moody’s Investors Service. The difference has narrowed from 40 on April 20.

Yield Spread

The extra yield investors demand to hold Russian debt rather than U.S. Treasuries fell 4 basis points to 221, according to JPMorgan EMBI+ indexes. The yield difference compares with 129 for debt of similarly rated Mexico and 196 for Brazil, which is rated two steps lower at Baa3 by Moody’s.

The spread on Russian bonds is 49 basis points below the average for emerging markets, down from a 15-month high of 105 in February, according to JPMorgan Indexes.

Russia’s budget calls for raising 1.2 trillion rubles of local bonds to help finance a deficit that may reach 2.4 trillion rubles, the government said in June. Sales have totaled 249 billion rubles so far in 2010, based on central bank data. About 75 percent of the nation’s $40.6 billion Reserve Fund may be used in 2010 to help make up for any shortfall, Pankin said last month.

“We will see who wins here,” said Mikhail Galkin, head of fixed-income research at in Moscow at VTB Capital, the investment banking arm of Russia’s second-largest lender. “The outcome of the game depends on how desperately the Ministry of Finance needs the money, on inflation dynamics as well as global risk appetite.”

To contact the reporter on this story: Emma O’Brien in London at eobrien6@bloomberg.net

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