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Navalny Highlights Investors’ Black-Box Conundrum: Russia Credit

Opposition Leader Alexey Navalny
Alexey Navalny, a political opponent of President Vladimir Putin, was released from custody on July 19 while he considers appealing the ruling. Photographer: Vasily Maximov/AFP via Getty Images

The conviction of Alexey Navalny, a political opponent of Russian President Vladimir Putin, highlights risks faced by investors as they weigh whether to buy assets in the world’s biggest energy exporter.

Russia, which earned about $350 billion from oil and gas exports last year, has a Baa1 rating at Moody’s Investors Service, on par with Mexico. The level “reflects weak governance, rule of law and transparency,” the firm said in a July 19 e-mail. That hasn’t deterred investors, with ruble bonds making 3 percent this year, compared with a 0.6 percent loss for emerging-market peers, according to JPMorgan Chase & Co. data.

The ruble tumbled the most in two weeks and Russian stocks, already the cheapest among 21 emerging markets tracked by Bloomberg, dropped the most in a month on July 18, when a court sentenced Navalny to five years in prison for embezzlement. The verdict sowed doubts about the rule of law in Russia, with U.S. President Barack Obama’s spokesman, Jay Carney, denouncing the conviction as part of a “disturbing trend” in Russia.

“Foreign investors see the political situation in Russia as a black box, which is a big risk to the country’s future,” Ogeday Topcular, a fund manager at Ram Capital SA in Geneva, which has $300 million of assets, said in an e-mail on July 19. “How much this risk is priced in is another question.”

Guilty Verdict

The yield on Russia’s benchmark February 2027 bonds jumped six basis points, or 0.06 percentage point, to 7.6 percent on July 18 before declining two basis points on the following day. That compares with a two-day increase of five basis points in the yield of Mexico’s 2027 security, whose yield stood at 6.11 percent on July 19. The rate on similar Polish notes fell 10 basis points to 4.21 percent.

Navalny was released from custody on July 19 while he considers appealing the ruling. His sentence is a “negative factor for the markets,” Russia’s Deputy Economy Minister Andrey Klepach told reporters in Moscow on the same day.

“We don’t have reason to believe that the verdict of this case can in any way affect the investment climate,” Dmitry Peskov, Putin’s spokesman, said in an interview on July 19. “On the contrary, it won’t have any effect because in all countries around the world there are high-profile legal cases.”

Capital Flight

On the day of the ruling, several thousand protesters gathered for an unsanctioned rally near the Kremlin in support of Navalny, who last year spearheaded the biggest protests against Putin’s 13-year-rule. Police detained some demonstrators and blocked off streets amid shouts of “freedom to political prisoners” and “Putin is a thief.”

“I certainly disapprove of the way Putin handles political opponents and, in the medium term and longer term, this line will do little to attract foreign direct investment or stop capital flight,” Michael Hansen, who helps manage about $1 billion in emerging-market debt as a senior strategist at Global Evolution AS in Kolding, Denmark, said by e-mail on July 19.

Russia is ranked as the most corrupt nation among the Group of 20 advanced economies in Berlin-based Transparency International’s 2012 Corruption Perceptions Index. The government’s capital outflow forecast for 2013 may be raised to $50 billion, compared with $56.8 billion last year, Deputy Economy Minister Klepach said on July 19.

Servicing Debt

Navalny is the latest prominent opponent to face prison.

Former Yukos Oil Co. owner Mikhail Khodorkovsky, 50, was detained in October 2003. Once Russia’s richest man, Khodorkovsky is serving a 13-year sentence. A Moscow court cut his sentence to 11 years in December. At least two other high-profile critics -- economist Sergei Guriev and former chess grandmaster Garry Kasparov -- have left Russia this year.

“While from a human rights perspective the sentencing of Navalny raises serious concerns, it has nothing to do with Russia’s ability to service its debt obligations,” Viktor Szabo, who helps oversee more than $10 billion in emerging-market assets at Aberdeen Asset Management in London, said by e-mail on July 19. “I don’t think it will have any market impact, unless street protests turn violent, which given the weakness and fragmentation of the opposition seems highly unlikely.”

The yield on Russia’s dollar bond maturing in March 2030 retreated five basis points to 3.705 percent at 7:37 p.m. in Moscow. The extra yield investors demand to hold Russia’s dollar debt rather than Treasuries fell two basis points to 206, compared with 185 for Mexico, according to JPMorgan indexes.

‘Secondary’ Issue

Russia’s credit-default swaps, contracts insuring the nation’s debt against default, slid three basis points, or 0.03 percentage points, to 161 today, according to data compiled by Bloomberg. This compares with 110 for Mexico’s CDS, and 88 for Poland.

Putin, who started his third term as Russia’s president in May 2012, vowed to sustain economic growth during his campaign, reverse “repressive” policies and protect private business.

“Russia’s governance indicators are definitely poorer than similarly-rated countries, this weakness is priced into the rating already,” Charles Seville, a director at Fitch Ratings, said by phone from London on July 19. “It’s part of the rating but it’s secondary to the economic and public finance issue. It would take a bigger event to change our view.”

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