Gadfly

Russia's Bond Had to Come. You Can't Disappoint Vlad

A tender, and the Presidential election, would make a cancellation extremely embarrassing.
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Russia is printing a new 11-year dollar-denominated eurobond today and adding to an existing 30-year -- surprising, perhaps, given the growing diplomatic row with the U.S. and U.K. With order books already over $6.5 billion it looks like an engineered show of bravado.

In reality, going ahead with the issue reflects a serious desire to avoid substantial embarrassment by showing that capital market access is prey to international pressure. While the deal was only formally launched on Thursday it had been flagged last week with the announcement of a $4 billion swap to buy back its high-coupon 7.5 percent 2030 bond. It would have been odd to pursue a buyback and not raise money at the same time. 

This deal had been coming down the track anyway, with Russia's 2018 budget stating the intention to come to the eurobond market this year. The timing is logical following S&P Global Ratings upgrade of the country's foreign-currency rating to BBB- on Feb. 23, which qualifies the country's government bonds again for most of the investment-grade bond indexes.

It's also practically mandatory, given the presidential elections on Sunday. While Vladimir Putin's victory seems pretty well assured, what's crucial for him -- and for the bond market -- is the turnout. In the 2012 elections, turnout was 65 percent, and Putin's share was 64 percent. Were either of those shares to drop by any noteworthy amount, investors would take that as a worrying sign that he's losing his grip, and demand a higher premium for the debt. 

As things stand, the terms on offer for new money being raised are certainly more generous than Russia might have achieved earlier this year. It will pay 4.625-4.75 percent for the 11-year and 5.25-5.375 percent for the 2047 tap.

But this is roughly in line with the broader market. Benchmark U.S. Treasury yields have risen since the start of the year.

Not Quite Lockstep, but Still...

This year's lift in Russian bond yields echos the gains in Treasury yields

Source: Bloomberg

And emerging market sovereign spreads have been widening recently.

It's Not Just Russia

Spreads for others at the low end of investment grade have also moved wider from record tight levels

Source: Bloomberg

A more narrow look at the pricing environment shows there's plenty of reason for issuers, including Russia, to forge ahead if they can. Heavy new issue supply this month has also meant higher premiums. Of 117 new bond deals in Europe in March, three-quarters of them are wider from launch. At the same time, underlying government bond yields both in the U.S. and Europe have ticked down in the past week, so all-in interest costs are little changed. 

And the political fracas is hardly likely to be enough to prompt the bulk of investors to stay away. With broader yields so low they'll be more than happy to pick up a few extra basis points on a new issue. Fitch had never cut Russia into junk territory so with an investment-grade rating at two of the main three rating companies there ought to be several billion dollars of passive index demand for Russian foreign and local currency debt. Russian private bank Otkritie owns a large part the bond being swapped in the tender, so that exchange looks likely to run smoothly.

The Ruble's Seen Worse

The currency is within the bounds of normal trading for the past year, despite recent volatility

Source: Bloomberg

Certainly demand was very strong for Gazprom's $750 million eight-year bond on Wednesday, which is half state owned and also benefits from newly-regained investment grade status. The order book was $2.3 billion and the lead managers were able to tighten the coupon in from 2.875 percent initial price talk to 2.5 percent, as well as increase the size from $500 million. So the appetite for Russian debt looks strong.

Russian Inflation

Price gains are well under control, removing a hurdle to investing in the country's debt

Source: Bloomberg

Russia's existing 10-year bond is trading at about 4.3 percent. When you account for the fact that the new issue is nearly two years longer, and there's a new issue premium to be considered, it looks like Russia's penalty for its political problems is about 10 basis points. That's really not that much.

Now is not the time, either politically or financially, for Russia to look weak by pulling a deal. Russian banks need these deals to invest their dollar liquidity. But even more key for Russia is to keep access to foreign capital open -- not least because diplomatic machinations highlight the risk that access could be curtailed in the future. Offering generous terms to investors sometimes makes longer-term sense. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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