Now, This Is Exotic Paper

Russian localities are getting set to sell Eurobonds

All across Moscow, workers are hanging banners and splashing on paint as the city spruces up for its 850th birthday party. Behind the scenes, Mayor Yury Luzhkov's government is preparing for another milestone. In the next few months, Moscow hopes to launch its first Eurobond issue, raising up to $500 million from U.S. and European investors to finance revenue-earning projects ranging from commercial buildings to high-tech startups. The city has already gotten solid marks from Western bond-rating agencies and has lined up Credit Suisse First Boston Corp. and Nomura Securities Co. to manage the issue.

That's just the beginning. Moscow is leading a pack of city and regional governments grooming themselves for Eurobond issues (table). "Moscow's borrowing program can become a model for other regions of Russia," says Mechislav V. Klimovich, chairman of the city's Capital Market Development Committee. Cheered by warm investor response to the federal government's first foray into Eurobonds this winter, they're opening their books to rating agencies and hiring Western advisers. Municipal Eurobond issues this year could reach $1.5 billion, some analysts predict. "It's an extremely exciting potential market," says Dirk Damrau, managing director of Moscow's Renaissance Capital investment bank.

REVENUE STREAMS. The Eurobond debutantes are expecting plenty of suitors. "The appetite for exposure to Russian municipals is quite strong," says David Boren, vice-president for economic and market analysis at Salomon Brothers Inc. in London. High-yielding government debt is in short supply worldwide, and Russian municipal Eurobonds are expected to yield more than the 9% paid out for the federal government's second Eurobond issue, in March. Moscow and Nizhny Novgorod, the first two jurisdictions to be reviewed by Moody's Investors Service and Standard & Poor's, won credit status equal to Russia's own Ba2 and BB- ratings.

Savvy investors will notice that some Russian cities and regions are in much better fiscal shape than the deficit-ridden federal government. Moscow, for example, rakes in revenues from vast real estate and business holdings, including a stake in local McDonald's restaurants. Nizhny Novgorod, an industrial region in the Volga River basin that's working with ING Barings Ltd. on an issue of up to $100 million, has become a magnet for foreign investment under Governor Boris Nemtsov, who was recently named a top member of President Boris N. Yeltsin's economic team.

Eurobonds make good sense for Russia's local governments, which need cash to repair infrastructure and spur growth. The domestic market for ruble-denominated municipal bonds is limited and pricey, with yields on recent issues running close to 30%. Although Moscow expects to issue more than $1 billion in domestic bonds this year, it is hungry for a shot at cheaper foreign financing. Moscow and Nizhny Novgorod say they'll jump in as soon as the Kremlin confirms that it won't place a 15% securities tax on their Eurobonds. St. Petersburg, now awaiting its bond rating, is close behind. Other regions planning Eurobonds include Sverdlovsk in the Urals and Irkutsk in Siberia.

PAPER CRUTCH? But even investors with a taste for exotic paper may find some of the offerings less than confidence-inspiring. There's concern that St. Petersburg, for example, which has plunged into domestic bonds, has become too dependent on debt to finance routine operations.

Most regions won't be invited to the party, though. The Kremlin has already announced that it won't permit a Eurobond issue by any jurisdiction that's being subsidized by the federal government. That rules out more than 70 of the country's 85 regions and many cities as well. Also, the Central Bank and the Finance Ministry are drafting rules to keep municipal Eurobond issuers from going too deeply into hock.

To reassure investors, Moscow has said it will establish a "pledge fund" containing highly liquid assets such as real estate and stocks that could compensate bondholders in case of a default. However, investors looking for ways to diversify may not need much encouragement. For Moscow, that means 1997 could be a very happy birthday indeed.

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