Russian Bonds Slump With Ruble as Rates Fail to Counter S&P Cut

Russian bonds slid, sending yields to a six-week high, after Standard & Poor’s cut the nation’s credit rating to one level above junk. A surprise interest-rate increase failed to prop up the ruble.

The yield on government debt due February 2027 jumped 24 basis points to 9.6 percent, taking this week’s advance to 60 basis points. The ruble weakened 0.8 percent versus the central bank’s target dollar-euro basket to 42.2613 by 6 p.m. in Moscow even as policy makers raised the one-week auction rate to 7.5 percent from 7 percent. Russia’s credit risk rose to the highest in more than two years and the Micex stock index closed down 1.6 percent, capping the worst week since the five days to March 14.

The rate increase, predicted by just one of 23 economists in a Bloomberg survey, failed to stem a selloff that has picked up pace as an accord to disarm separatists in east Ukraine unravels. S&P lowered Russia’s rating to BBB- from BBB, saying more downgrades are possible if the economy deteriorates and the U.S. and Europe expand sanctions.

“What we’re seeing now is a pretty permanent exodus from Russia,” Lars Christensen, chief emerging-market analyst at Danske Bank A/S in Copenhagen, said by phone. “It will be very difficult for the central bank to fight it because a consequence of this is a further drop in economic activity. Given the geopolitical risk, given that this shock has been of a permanent nature, I think the S&P downgrade is fully justified.”

More Outflows

The ruble initially trimmed declines against the dollar before resuming its retreat, the second-biggest today among 24 emerging-markets monitored by Bloomberg after the Brazilian real. The exchange rate depreciated 0.9 percent versus the greenback to 36.0661, erasing its gain since President Vladimir Putin’s intervention in Crimea started on March 1.

Putin’s annexation of the Black Sea peninsula later that month triggered the worst standoff with the U.S. and Europe since the collapse of the Soviet Union, leaving policy makers to struggle with an economy on the brink of recession and an inflation rate above the central bank’s target for a 19th month.

Credit-default swaps insuring Russian debt against non-payment climbed as much as 18.5 basis points to 284 after the S&P cut, the highest since January 2012, before trading at 279.25 by 18:54 p.m. in Moscow. Last month, Russia was placed on review for a downgrade by Moody’s Investors Service and Fitch Ratings cut its outlook to negative.

Anxious Investors

S&P’s “negative outlook will keep investors anxious,” Igor Golubev, head of fixed-income research at OAO Promsvyazbank, said by phone from Moscow. The move “has only partially been priced in” and Russia runs the risk of being lowered to BB+ by S&P at its next review in July, he said.

A “tense geopolitical situation” may spur further capital flight and “undermine” the weakening economy, the ratings company said in its report today. Economic growth in the country of about 140 million people is set to slow to 1 percent this year, the lowest since a contraction in 2009, according to the median of 40 forecasts compiled by Bloomberg.

Policy makers last increased the key interest rate by 150 basis points in early March, seeking to stem outflows from Russian assets. The ruble reversed its gains as pro-Russian separatists in eastern Ukraine took over official buildings, prompting speculation more cities may follow Crimea’s example.

An April 17 agreement signed in Geneva by the U.S., European Union, Russia and Ukraine called on illegal groups to disarm and return seized buildings.

Expanding Sanctions

The U.S. and its allies have an additional list of sanctions ready and will act if there is no progress in de-escalating the crisis in Ukraine, where security forces are moving against pro-Russia separatists, U.S. President Barack Obama said yesterday in Tokyo.

The Micex Index decreased to 1,280.12, taking this week’s retreat to 5.6 percent, the worst since the five days before Crimeans voted in a referendum to join Russia. OAO Sberbank, the nation’s biggest bank, slumped 4.5 percent, while OAO Magnit, the largest food retailer, dropped 4.2 percent.

The rating downgrade will hurt Russian stock valuations “as it effectively increases the required rate of return investors demand for investing in Russia,” Vyacheslav Smolyaninov, a strategist at ZAO UralSib Capital in Moscow, said in e-mailed comments.

Russia-focused equity funds saw a $67 million outflows in the week to April 23, while bond funds posted an inflow of $57 million, according to EPFR Global data, cited by ZAO UralSib Capital and OAO Gazprombank.

Potential Targets

Gazprombank, Russia’s third-largest lender, is a potential target for sanctions, said a U.S. official, who asked not to be identified because the information is confidential. Another Russian state-controlled financial institution, development lender Vnesheconombank, is taking precautionary measures against possible sanctions, according to one person familiar with talks at that bank. Spokesmen for Gazprombank and VEB, as it’s known, declined to comment.

The yield on Gazprombank perpetual Eurobonds jumped 1 percentage point to 10.18 percent, the highest on a closing basis since March 17.

“Russia is now just a notch above junk status,” Smolyaninov said. “Hence, expect a bunch of downgrades for quasi-sovereign banks and corporates. And higher costs of funding are here to stay.”

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