Sole underwriter.

Photographer: Alexander Zemlianichenko Jr/Bloomberg

Russia May Be Toxic, But Domestic Investors Don't Mind

Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.
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Can a major sovereign borrower issue eurobonds without the help of major Western banks and clearing systems? Russia has just proved this possible, but it’s likely that Russian investors will end up buying most of the country’s first bond issue since it was hit with Western sanctions.

Thanks to cheap oil, Russia now faces its biggest budget deficit since 2010 -- 3.8 percent of gross domestic product, according to the Bloomberg consensus forecast, though President Vladimir Putin has set a 3 percent target for the government. In January through April, the deficit was even higher than forecast -- 1.23 trillion rubles ($18.3 billion), or 4.7 percent of GDP. But with Russian government debt at only 13.5 percent of GDP, there is plenty of room to borrow.

QuickTake Sanctions

The government has been using its oil reserve fund to cover the deficit, but the budget also allows it to borrow $3 billion on the international markets. That, however, is easier said than done. In February, the government took the usual route and sought a Western underwriter for a debt issue, sending out letters to 25 major international banks. Banks these days only have as much room as their compliance departments dictate and in matters involving sanctions, and U.S. and European Union authorities left the compliance people little wiggle room on any Russian bonds. 

Though Russia as a sovereign borrower is not under sanctions, the U.S. State and Treasury departments warned banks of the “reputational” risks of “business as usual with Russia.” The EU did the same privately, warning of the potential use of bond proceeds for purposes that contravene the sanctions. Though the warnings weren’t binding, bankers knew they ignored them at their peril. The tens of millions of dollars the underwriters could make on, say, a $1 billion Russian bond issue wouldn’t be worth the trouble. So Goldman Sachs, JP Morgan, Barclays, BNP Paribas and every other Western bank Russia invited balked.

Finance Minister Anton Siluanov initially brushed off the rejections and suggested Russia didn’t need to tap markets anyhow. “The ruble is strengthening because oil prices are growing, and the additional inflow of capital from eurobonds will only make the ruble stronger still,” he said in April. “Do we need that? We don’t really think we do.”

By the end of the month, though, the higher-than-expected deficit apparently changed that calculus, especially since there was a way to issue the eurobonds without strengthening the ruble and creating budgetary problems. If enough Russian investors bought dollars for rubles in order to bid for the bonds, the Russian currency would weaken. 

As of May 1, the Russian Central Bank had provided $15.8 billion worth of liquidity to Russian banks. If part of that money is used to buy the bonds, the finance ministry will sell some of the dollars to the central bank for rubles (as it intends to do, according to the bond prospectus), mopping up the excess dollars and putting downward pressure on the ruble’s exchange rate.

For Russian investors -- and big local brokerages such as Aton and Uralsib bid for the new 10-year bond immediately -- the offering is perfectly convenient and conventional. The book is run by state-controlled VTB Capital, and the purchases are cleared through the National Settlement Depository, which does settlements for the Moscow Exchange (Euroclear and Clearstream stayed away for the same reason as the potential underwriters).

For foreigners who don’t trade on that exchange and who only know VTB as a co-underwriter of Russia’s 2013 bonds along with some major Western financial institutions, this setup is exotic, especially considering that is under sanctions in the U.S. and the EU and it wouldn’t be able to place its own bonds.

Russia has offered an attractive yield range on the 10-year bond -- 4.65 to 4.9 percent, roughly in line with how Russian eurobonds that mature in 2028 are trading and a little more than for Turkish debt that matures in 2026. That’s quite a lure, given that about $10 trillion of sovereign debt now trades at negative yields. Yet under the watchful eyes of compliance departments, it’s better for foreigners to sit out the primary market offering and pick up the bonds when they start trading on the open market.

Siluanov, however, is not just concerned with selling the bonds (it’s not clear yet how much the government will end up selling), but with the quality of the investor pool. He said in April that he’d be looking for the same type of big institutional investors as in 2013. Although VTB Capital could have closed the book on Monday night, when it had $5.5 billion worth of orders, it kept it open to tempt some Asian investors, who might turn out to be less jumpy than Western investors. Tuesday morning, subscription increased to $6.3 billion -- not a huge jump, but good enough for a market test.

The results of the unorthodox placement should tell Siluanov two things: That the Russian government won’t have much trouble borrowing the modest amount of money allowed by the budget, and that, despite the lack of formal sanctions against it, Russia as a sovereign borrower is more toxic than chronically deadbeat Argentina, which easily raised $16.5 billion last month amid demand for $70 billion worth of bonds (albeit offered at a 7.5 percent yield for 10 years). 

The latter, however, may change once the new bonds hit the secondary market. If investors can trade them without any problems despite Russian clearing, they will be just another high-yield market instrument, like Russia’s existing, liquid bonds. And it’s likely that the next issue will be easier to sell to foreign entities even without Western banks and settlement systems. Sanctions may prove no contest for investors in these yield-starved times.

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

To contact the author of this story:
Leonid Bershidsky at lbershidsky@bloomberg.net

To contact the editor responsible for this story:
Therese Raphael at traphael4@bloomberg.net