Rampant Inflation in Russia Is Basis for World-Beating Linkers

  • Barclays to add notes to indexes, enlarging audience for funds
  • Finance ministry to tap 2023 issue at Wednesday's auction

While inflation may be the biggest problem for Russia’s central bank, it may also be the key to unlocking a new source of foreign capital: via index-linked bonds.

With the second-fastest rate of consumer-price growth in the developing world, Russian linkers have returned 8.5 percent since they were first offered in July, luring buyers such as the California Public Employees’ Retirement System, or Calpers. Credit Suisse Group AG has touted them as an alternative to regular bonds and they’re about to get included in Barclays Plc indexes starting in February, opening the market to mutual funds that use the gauges to measure their own performance.

Russia sold 30 billion rubles ($465 million) more of the 2023 bonds today in an auction that drew 2.4 times more orders than bonds available, the Finance Ministry said. The notes were offered at 99.41 percent of face value, paying real average interest of 2.72 percent. Appetite will persist even as policy makers try to quell inflation that’s four times the central bank’s target, said Luis Costa, the chief fixed-income strategist for central and eastern Europe, the Middle East and Africa at Citigroup Inc. in London. Russia’s 15.6 percent inflation rate trails only Venezuela in emerging-market economies.

Investors bid up bonds that hedge inflation risk
Investors bid up bonds that hedge inflation risk

“Investors will demand some inflation hedge, so demand for linkers will be very good," Costa said by e-mail. The inclusion of the notes in the Barclays index “is a very positive development,” he said.

Gains on Russian inflation-linked notes have exceeded those of 20 nations in a Bank of America Merrill Lynch index since they were first sold. Although Russia is not part of the Merrill index, it will be added to the Barclays Emerging Markets Government Inflation-Linked Bond Index, Barclays said in a statement Monday. 

When the bonds were included in an auction for the first time on Oct. 14, Calpers found it was outbid as orders exceeded the amount available by almost five times, Mike Rosborough, a Sacramento, California-based senior portfolio manager at the fund, said in an interview that day.

Some analysts aren’t convinced demand for the notes will be sustained as inflation starts to decelerate next year and leads to higher real yields. Most strategists expect policy makers will succeed in stabilizing the ruble and curbing inflation, with the median forecast of 21 economists showing consumer price growth will slow to 7.7 percent in a year’s time.

No Exit

Alexander Sychev, an analyst at Rosbank PJSC, the Russian arm of Societe Generale SA, expects inflation to drop to 6.7 percent by the end of next year and prefers nominal debt, he said by e-mail.

Low liquidity is another drawback. Index-linked notes rarely trade, making it hard to exit positions, said Paul McNamara, a fund manager at GAM UK Ltd. in London. The inclusion of Russian linkers to Barclays’ indexes would result in “tiny inflows” because the index isn’t widely used as a benchmark, he said. Susie Guo, a spokeswoman for Barclays in London, said the bank doesn’t give estimates on the number of funds pegged to its indexes.

Inflation-linked debt compensates holders for rising consumer prices through higher principal payments. At the same time, the ruble’s 21 percent decline against the dollar in the past six months, the steepest drop among emerging-market currencies after Brazil’s real, contributes to faster inflation by increasing the local-currency price of imports.

The securities rose Wednesday, briefly reaching a record 99.49 percent of face value, with the real yield declining six basis points to 2.60 percent. They have risen from an inititial issue price of 91 percent in July.

Intensifying consumer-price growth and a bout of currency weakness forced the Russian central bank to refrain from cutting interest rates for the second consecutive month in October, denying relief to an economy battered by its first recession in six years. Policy makers paused their easing cycle in September for the first time in 2015 after six percentage points of interest-rate cuts brought their benchmark to 11 percent.

“It’s a logical approach at a time like this when you don’t have a major recovery,” Stuart Quint, chief international strategist who helps manage $17.5 billion at Brinker Capital Inc., said Tuesday. “In Russia’s case, inflation-linked bonds is something that will probably stick around.”

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