Putin Bonds Trail Emerging Markets for Seventh Month on Oil: Russia Credit

Russian bonds are trailing emerging- market debt for a seventh straight month, sending Prime Minister Vladimir Putin’s borrowing-cost advantage to near the lowest since October as falling oil prices curb economic growth.

The country’s dollar debt returned 2.2 percent this month, compared with the 2.4 percent average gain for developing nations and extending the longest stretch of underperformance since 2006, JPMorgan Chase & Co.’s EMBI Global indexes show. Russian borrowing costs were 62 basis points, or 0.62 percentage point, less than emerging-markets on Aug. 27 and touched 50 on Aug. 11, the smallest gap in 10 months. The spread was 101 in January.

Russia is facing higher debt costs after a 5.6 percent drop in oil this month to $74.51 a barrel, below the $123 average needed to balance the government’s budget this year, according to estimates from Moscow-based Alfa Bank. The Economy Ministry predicts Russia’s worst drought in half a century will weigh on economic growth after reports this month showed rising unemployment and slowing industrial output.

“The underperformance of Russian bonds is probably related to the poor industrial production data and the issues surrounding the heatwave,” Clemens Grafe, chief economist at UBS AG in Moscow, said in a phone interview Aug. 27. Russian debt will probably continue to trail bonds of other developing nations, he said.

The extra yield investors demand to own Russian bonds over U.S. Treasuries has climbed to 245 basis points from this year’s low of 144 on April 14, a week before the government sold $5.5 billion of securities in the first offering on international capital markets since the government’s 1998 default, according to JPMorgan’s indexes. Russia has a BBB credit rating from Standard & Poor’s, the second-lowest investment grade.

Outlook Worsens

The outlook for global economic growth has worsened since April as indebted European governments cut spending, China took steps to cool property speculation and reports signaled the U.S. labor market may be slow to recover.

Oil, Russia’s biggest export earner, has dropped 14 percent from this year’s closing high of $86.84 a barrel in New York trading on April 6, according to data compiled by Bloomberg. Oil has averaged about $78 this year.

The country’s Reserve Fund, a sovereign wealth fund comprised of extra oil revenue, dropped to $40.6 billion in July from $60.5 billion in December and the government may use about 75 percent of the fund this year to make up any budget shortfall, Deputy Finance Minister Dmitry Pankin said last month.

Pankin couldn’t be reached when Bloomberg News called for comment on Aug. 27.

More Risk

“Russia is an oil story and there is more risk to them if there is a downturn,” Henry Stipp, a fund manager in London at Threadneedle Asset Management, which manages about $90 billion, said in an interview on Aug. 27.

Russian industrial output expanded at the slowest pace in eight months in July, missing economists’ forecasts, as record- high temperatures forced some manufacturers to halt production, the government said on Aug. 16.

The nation’s drought and wildfires, which killed more than 50 people and left 3,300 homeless, will cost the economy as much as 0.8 percentage points of growth this year, leaving the expansion at 4 percent, Deputy Economy Minister Andrei Klepach told reporters in Moscow on Aug. 24.

The 2.2 percent return on Russian debt compares with the 2.5 percent gain for Mexico, which has the same BBB rating as Russia at S&P, according to JPMorgan indexes. Brazilian bonds, rated one step lower at BBB-, advanced 2.4 percent so far this month.

Bond Risk

The cost of protecting Russian debt against non-payment for five years with credit-default swaps rose 2 basis points to 179 on Aug. 27, according to prices from data provider CMA. Credit- default swaps, which rise as perceptions of creditworthiness worsen, 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.

The yield on ruble bonds sold by state-controlled gas producer OAO Gazprom is 233 basis points above the same-maturity Gazprom debt in dollars, down from a yield difference of about 600 a year ago, data compiled by Bloomberg show. The spread narrowed to as little as 115 on June 14.

The ruble was little changed at 30.6800 against the dollar by the 5 p.m. close in Moscow. Non-deliverable forwards, or NDFs, which provide a guide to expectations of currency movements and interest rate differentials, show the ruble weakening to 30.9200 per dollar in three months.

Budget Deficit

While the Russian government estimates it will face a budget deficit this year, the shortfall is smaller than the average 6.9 percent of gross domestic product gap for Group of 20 countries projected by the International Monetary Fund.

“The budget deficit compared to other countries is absolutely under control,” Luis Costa, a London-based emerging markets strategist at Citigroup Inc., said in an interview Aug. 27. “The fiscal story is good.”

Elena Kolchina, head of fixed-income products at Renaissance Asset Managers in Moscow, said she favors Ukrainian debt because yields are more attractive than in Russia. The extra yield on Ukraine’s dollar-denominated debt over U.S. Treasuries is 514 basis points after the bonds returned 31 percent this year, according to JPMorgan. That compares with an 8.7 percent gain in Russian debt, JPMorgan data show.

“Russian economics are still strong,” Kolchina said in an interview Aug. 27. The country “is simply out of fashion now,” she said.

To contact the reporters on this story: Michael Patterson in London at mpatterson10@bloomberg.net; Jason Corcoran at Jcorcoran13@bloomberg.net.

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