Putin Peace Dividend Already Banked as Default Risk Drops

Russian sovereign risk is falling to levels not seen since January as peace talks with Ukraine show signs of progress in resolving the three-month conflict.

The cost to insure government debt against non-payment for five years slid 29 basis points this month to 164 basis points on June 9, the lowest level in five months and three times the decline of similarly rated Brazil, data compiled by Bloomberg show. The credit default swaps may reach a nine-month low of 140 basis points within six weeks, according to Jefferies International Ltd.

Talks between Russia, Ukraine and the Organization for Security and Cooperation in Europe in Kiev have a “real possibility of achieving a cease-fire,” OSCE Chairman and Swiss President Didier Burkhalter said yesterday, even as Ukrainian troops repelled attacks, killing 43 rebels.

“The Ukraine risk premium has almost disappeared,” Denis Poryvay, an analyst at ZAO Raiffeisenbank in Moscow, said by phone on June 9. “Ukraine wants to end the military operation and the EU and U.S. have held off making negative statements regarding new sanctions. The de-escalation of the conflict is apparent.”

Ukraine’s U.S. and European Union allies have imposed sanctions on Russia and threatened to tighten them unless President Vladimir Putin acts to halt the conflict in which hundreds have died and more have been abducted in fighting between the rebels and government troops.

Withdrawal Pledge

Standard & Poor’s cut Russia’s debt rating to the lowest investment-grade ranking on concern sanctions will hurt economic growth. Russian five-year CDS surged to the highest level since January 2012 on April 25.

The cost of the contracts has plunged since as Putin pledged to withdraw troops from the border with Ukraine and to respect the results of the country’s presidential elections.

Russia’s CDS cost 19 basis points less than the average for governments in the central and eastern Europe, Middle East and Africa region, within two basis points of the widest discount since April, data compiled by Bloomberg show.

Still, the level is 32 basis points above similarly rated Brazil. Russia depends on oil and natural gas sales for about half of its budget. There’s a 50 percent probability the Russian economy will slip into a recession in the next 12 months, according to the median forecast in a Bloomberg survey.

Russian ‘Mercenaries’

“Russia’s persistently high reliance on commodities exports and its inability to reform and diversify its economy increases its vulnerability to an eventual drop in commodities prices,” Viktor Szabo, a London-based money manager who helps oversee more than $11 billion in emerging-market debt at Aberdeen Asset Management Plc, said by e-mail on June 9. The difficulty of predicting Russia’s foreign policy actions also contributes to the higher risk premium, he said.

Ukrainian President Petro Poroshenko said at his June 7 inauguration that he would draft plans to decentralize power and proposed a partial amnesty and free passage for Russian “mercenaries.”

Russian government bonds in rubles have rallied, driving the yield on OFZs due August 2023 down 28 basis points this month. The yield rose four basis points today to 8.43 percent while the CDS increased one basis point to 172 at 12:50 p.m. in Moscow.

“The key reasons behind the recent drop in Russia’s CDS are of course the signs that Russia is distancing itself from the crisis in Ukraine, which in turn has eased the concerns over further Western sanctions,” Liza Ermolenko, a London-based emerging-market economist at Capital Economics Ltd., said by e-mail yesterday. It’s unlikely the CDS will fall much further because of the economic outlook, she said.

The cost could drop to as low as 140 basis points within four to six weeks, Richard Segal, international credit strategist at Jefferies in London, said by e-mail on June 9. “There should still be upward momentum,” Segal said.

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