Meet Putin’s New, and Poor, Neighbors in the Debt Market

Just how much has President Vladimir Putin’s Ukraine incursion eroded investor confidence in Russia?

Consider the names that the country is now surrounded by in the market where bondholders buy protection against default: Lebanon, El Salvador and war-torn Iraq. With investors charging 389 basis points a year to insure against a halt in Russian debt payments, those three countries -- all of which either have junk ratings or none at all -- are quoted at the closest levels to Putin’s government in the credit-default swaps market, according to CMA.

The cost of Russian credit-default swaps rose for the 11th straight day to a five-year high today, the longest run of increases since at least 2008, CMA data show. The country is heading toward recession as U.S. and European Union sanctions over Putin’s actions in Ukraine crimp access to foreign funding, while crude oil, the nation’s chief export earner, plunges into a bear market.

“All the problems that had accumulated in the Russian economy for years are now visible to all,” Konstantin Artemov, a money manager at Raiffeisen Capital Asset Management, who helps oversee $500 million, said by phone from Moscow Dec. 5. “Even if there’s no default, its chances are rising as there are problems with the budget because of falling oil prices.”

Closing ‘Channels’

Ruble government bonds tumbled, with 10-year yields jumping 146 basis points last week to a five-year high. The rate increased a further 54 basis points to 12.61 percent at 4:46 p.m. in Moscow. The currency has tumbled 13 percent over 10 days, touching a record low at 54.9090 per dollar on Dec. 3 before central bank interventions propped it up to 52.51 at the end of last week. It depreciated 1.8 percent to 53.4385 today.

Penalties over Crimea and Putin’s backing of pro-Russian separatists in east Ukraine have limited access to international capital markets for companies, pushing some of the largest, including oil producer OAO Rosneft, to request state aid as debt redemptions loom. The government has also scaled back bond sales as yields surged.

Credit-default swaps “reflect worse fundamentals, the much lower number of financing channels open to Russia and marginally the possibility of sanctions that affect foreign holdings of Russian bonds,” Paul McNamara, a money manager at GAM UK Ltd. in London, who helps oversee $6.3 billion of sovereign debt, said by e-mail.

The Finance Ministry’s press service didn’t immediately respond to an e-mailed comment request today.

‘Value Trade’

The price of oil, which together with natural gas accounts for about half of Russia’s government revenue, dropped 38 percent this year to a low of $68 a barrel amid the highest U.S. output in more than three decades.

Even after spending about $80 billion to manage the ruble’s retreat this year, Russia has more than $400 billion in international reserves, according to central bank data. While a weaker ruble has hurt consumer spending, it benefits the budget by boosting export revenue in local-currency terms, helping to offset the slump in crude.

Russia’s total sovereign debt is equal to 9.2 percent of gross domestic product, the second-lowest among 50 countries tracked by Bloomberg. Brazil, with the same credit score as Russia from Standard & Poor’s and whose CDS trade at 166 basis points, owes the equivalent of about 72 percent of GDP.

The country has “low debt levels, huge reserves and a flexible exchange rate, which insulates public finances from changes in global oil prices,” Jan Dehn, the London-based head of research at Ashmore Group Plc, which manages about $70 billion in emerging-market assets, said by e-mail. Russian assets are a “very good value trade,” he said.

Bailout ‘Burden’

The cost of Russian credit-default swaps has more than doubled this year as S&P cut the sovereign to the lowest investment grade in April. Unrated Iraq’s swaps are at 335 basis points, while junk-level Lebanon’s at 365 basis point and El Salvador at 415, according to CMA data.

“Investors see the main risks for Russia as having to conduct a large bailout of the economy at the same time as a recession and drop in living standards,” Dmitri Petrov, an analyst at Nomura Holdings Inc. in London, said by e-mail. “These factors clearly increase their burden on the sovereign with time, which means these risks will get gradually magnified, pushing the CDS even higher.”

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