Russia Sees Risks Emerging as Foreigners Amass State DebtScott Rose
Russia’s financial industry faces risks from surging demand for domestic ruble bonds as investors plow into the securities, competing with local banks for the assets used as refinancing collateral, the central bank said.
Non-resident holdings of ruble-denominated sovereign notes, known as OFZs, are now approaching the emerging-market average of 30 percent, compared with 21 percent on Feb. 1 and 7 percent on July 1, 2012, the Moscow-based regulator said in a report today. Bank Rossii and the Finance Ministry plan to start monitoring foreign ownership of OFZs to reduce risks.
“We don’t consider the situation to be critical at this point, or that it requires any immediate action from the central bank or Finance Ministry,” Vladimir Chistyukhin, head of the regulator’s financial stability department, told reporters in Moscow today. “At the same time, we do see potential risks.”
The report highlights the downside of Russia’s move this year to allow foreign investors to buy OFZs through systems run by Euroclear Bank SA and Clearstream International SA. Russia’s state debt market “collapsed” in 1997 and 1998 because of the dominance of foreign investors and the government’s weak financial position, according to the report.
The added demand has sent yields tumbling for the state and companies, while leaving Russia more exposed to fluctuations in global financial markets, according to the central bank. The country defaulted on $40 billion of domestic debt in 1998.
Yields on Russia’s 10-year debt fell to 6.48 percent on May 7, the lowest since February 2008, according to data compiled by Bloomberg. The yield on OFZs due January 2023 retreated for the first time this week, dropping four basis points, or 0.04 percentage point, to 7.31 percent as of 2:04 p.m. in Moscow.
“The drop in interest rates on the sovereign debt market was followed by a correction in yields for corporate bonds,” the central bank said. “In many instances, borrowing costs for sub-investment grade issuers have fallen below the rates on retail deposits in the biggest banks. That shows a possible underestimation of the risks of investing in bonds.”
The share of foreign OFZ ownership may rise to 50 percent, according to preliminary estimates, Chistyukhin said. A level of more than 40 percent would prompt discussions with the Finance Ministry on possible steps, he said.
Comments by Federal Reserve Chairman Ben S. Bernanke that the U.S. central bank plans to taper its bond buying program may “at least stabilize” the share of non-residents on the OFZ market, Sergei Moiseev, deputy head of the stability department, said at the press conference.
“If some sovereign fund or private investment fund even wanted to open a position of 1 percent or 2 percent for Russia, they could simply consume our entire market,” Moiseev said. “So no matter what Bernanke says, I think that reason -- the small size of our market -- means the share of non-residents will grow.”
After adjusting for inflation, one-year OFZs yielded a negative 1.5 percent at the end of the first quarter, while holders of 10-year notes were left with essentially no real return, according to the report.
“The current level of nominal yields is acceptable for non-residents, who have low funding costs,” the central bank said. “For residents, however, the negative real ruble rates mean, essentially, subsidizing the federal budget.”
A deterioration in risk perception because of events in the euro area threatens to drive up bond yields on OFZs, saddling banks with losses, according to the report.
That may also spur “speculative pressure in the currency market” as non-residents would need to convert their rubles from the sale of OFZs back into foreign currency, the bank said.
Still, Russia is benefiting from a diversification of the investor base, the central bank said. Sovereign funds from Europe and Asia have become major OFZ holders since the market was opened.
The U.K. accounted for 40.4 percent of OFZ ownership through Euroclear as of April 1, followed by 26.6 percent in the U.S., 8.5 percent in Luxembourg and 6.3 percent in Singapore, according to the report.
As of May 2013, the banking industry had “an adequate store of unused potential for refinancing to handle potential liquidity shocks,” according to the report.
Russia’s 30 biggest banks plus the 10 other lenders most active on the money market had about 1.1 trillion rubles ($34 billion) in unused market assets and more than 2 trillion rubles in non-marketable assets and guarantees.
“As such, at present there aren’t any preconditions for the formation of a systemic liquidity deficit, and liquidity risks for the largest lenders are insignificant,” the central bank said.