Russia Can Quadruple Its Domestic Debt and Get Away With It

  • Raising domestic debt up to 40% of GDP not risky, survey finds
  • Russia more than tripling net borrowing in 2017 to aid budget

If Russia is walking into a “debt trap,” it still has a ways to go before a surge in borrowing threatens the economy, a Bloomberg survey showed.

Domestic debt can climb to 40 percent of gross domestic product from its current level of near 10 percent before becoming a source of systemic risk, according to 11 of 17 economists in the poll. Following Russia’s first Eurobond sale since 2013, most respondents believe the government will return to the international market again next year to offer more than the $1.75 billion placement last month.

“Russia’s economy can digest an increase in the government’s domestic borrowing,” said Wolf-Fabian Hungerland, an economist at Berenberg Bank in Hamburg, Germany. “There will be no flood of government debt, but a slowly rising tide.”

A crisis tearing at the economy for a second year is upending assumptions about Russia, forcing President Vladimir Putin to reconsider his misgivings about debt almost two decades after the government defaulted on $40 billion of domestic bonds. With no plans to balance the budget before 2019 after the collapse in oil prices, Bank of Russia Governor Elvira Nabiullina warned this month that attempts to spur growth through state borrowing will result in a “debt trap” and should instead focus on luring private investment.

Next year’s 1 trillion-ruble ($15.6 billion) plan for net borrowing is already more than triple the goal in 2016. As cheaper oil squeezes revenue, the cost of servicing bonds reached 8.6 percent of budget revenue last year, compared with less than 2 percent before 2008 at the end of Putin’s second term, according to Movchan Advisers in Moscow.

Still, the state won’t crowd out corporate issuers, most economists in the survey said. The government’s gross domestic borrowing program of 1.5 trillion rubles will force companies to pay 63 basis points more on average to sell debt in 2017, according to the poll.

Investor interest in the nation’s debt has picked up since the Bank of Russia embarked on a five-step easing cycle last year. It resumed interest-rate cuts this month after an 11-month pause, cutting the benchmark to 10.5 percent from 11 percent.

For analysis of the growing appeal of Russian debt, click here

Russian local-currency bonds have returned 20 percent in dollar terms this year, the second-most in the Bloomberg Emerging Market Local Sovereign Index. The yield on five-year government securities is near the lowest in almost two years.

‘Very Carefully’

The widest budget deficit since 2010 is pushing the government into measures from spending cutbacks to sales of state assets to cover a gap estimated at about 3 percent of GDP. The shortfall was at 4.3 percent of output in the first half, according to Finance Minister Anton Siluanov.

Pledging to proceed “very carefully” with borrowing at home, Siluanov has warned against the kind of debt binge that drove Russia to default. To fund the deficit in 1998, the Finance Ministry relied on securities that ranged in duration from three months to one year. Their yields exceeded 100 percent by August that year and the government defaulted. Putin became prime minister under President Boris Yeltsin a year later.

“The default threshold for Russian sovereign debt has historically been quite low,” said Sergey Narkevich, an analyst at Promsvyazbank PJSC in Moscow. “The high dependence on oil poses an obvious threat for the stability of budget revenues, and default history prevents high sovereign credit ratings.”

Longer Duration

The critical difference with 1998 is the duration of Russia’s debt. The weighted average maturity of its bonds is among the longest among the Group of 20 countries at 7.61 years, compared with 6.03 for China and 7 in Brazil.

If needed, the government may even increase this year’s domestic borrowing by shifting the unused portion of what it’s allowed to issue abroad -- or $1.25 billion -- into debt sales at home, Siluanov said Wednesday.

For now, the Finance Ministry isn’t planning to sell Eurobonds again next year. But even after a contentious placement in June that met resistance from Western governments and banks, Russia will return next year, according to Danske Bank A/S.

“The government will continue ‘to test the market,’ coming back to Eurobond issuance in 2017,” said Vladimir Miklashevsky, chief strategist at Danske Bank in Helsinki. “In order to avoid pressure on the fiscal side, Russia will use a freely floating ruble to adjust energy revenues in FX to expenditures in rubles.”

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