International -- Finance: Debt Issues
Western Banks to Russia: All Is Forgiven (int'l edition)
They were burned by the 1998 debt default, but they're back
To hear Western investment bankers talk about Russian debt today, you'd never guess that barely two years ago most fled Moscow after a bad mauling. Russia had defaulted on domestic debt, devalued the ruble, and frozen payments on some Soviet-era commercial debt. The price of a 30-year Eurobond issued just before the crisis plunged to 15 cents on the dollar, and the markets dried up. The U.S. and European banks, which lost some $10 billion to the debt default alone, cried highway robbery and vowed never to go near Russia again.
Now those same banks are hailing the former pariah's first step toward a return to international bond markets in the form of a massive issue of restructured commercial debt, which some say could become an emerging-markets benchmark. And they are looking forward to a possible new Eurobond issue next year.
What's behind this case of collective amnesia? Russia was the best-performing fixed-income market in the world this year and last, as measured by J.P. Morgan's Emerging Markets Benchmark Index. Year-to-date, it shows that Russia's commercial foreign debt has risen an average 54.2% in price vs. a 12.8% average for all emerging markets. To be sure, trading volumes are just $250 million a day--no more than a quarter of the cash that washed through the markets daily before the crisis. But Russia's debt bazaar has clearly bounced back from the August, 1998, crash, along with the Russian economy.
Luck has played a big role in Russia's improving outlook. Oil prices have surged, while the ruble's devaluation has fed an export-driven rebound in industrial production. These twin bonanzas have helped generate a budget surplus equivalent to 2.4% of gross domestic product and allowed the central bank to almost double foreign reserves, to $24 billion.HIGH MARKS. Russia's economy is expected to grow--yes, grow--by about 5.5% this year. Investors have been heartened by the political stability under President Vladimir V. Putin. Prime Minister Mikhail Kasyanov, a former Finance Minister, gets high marks for his stewardship of the economy. The government is making businesses and consumers pay in cash instead of barter and is starting to trim growth-choking corporate taxes. Fiscal policy has tightened, and the government has used most of the budget surplus to pay down International Monetary Fund loans. "The new administration is eager for Russia to be perceived as worthy of G-8 status," says Marcel Cassard, Deutsche Bank's London-based chief economist for the region, who has followed Russia's debt travails closely.
There are now several ways for outsiders to play the Russian boomlet. Moscow has just completed a restructuring of some $32 billion in Soviet-era commercial debt with the so-called London Club of creditor banks. The banks wrote off $10.6 billion, and Russia issued two new tranches--an $18.2 billion 30-year issue and a $2.8 billion 10-year issue--covering the balance.
In late August, ratings agencies boosted Russia's status for the first time since before the crisis, and now Moody's is considering doing so again. An upgrade would move Russian debt out of the high-risk category and back into the same class as benchmark emerging-market powerhouse Brazil. Restructuring $42 billion of Soviet-era debt with the Paris Club of sovereign creditors would also improve the outlook for Russia's bonds. Formal negotiations are slated for November.
Still, the country's fragile recovery could come tumbling around investors' ears again. After all, Russia labors under a staggering $155 billion of foreign debt. Crunch time for Russia could come as soon as 2003, when it faces foreign-debt repayments totaling $18 billion, a hefty rise from $10.2 billion this year.
Government officials say they hope to sustain today's growth to assure creditors that Russia can pay. But those hopes rest on shaky foundations. There are signs that devaluation-driven industrial growth is petering out because the ruble is appreciating in real terms against the dollar. And the big question is how Russia will fare when soaring oil prices fall again, as they inevitably will. "Oil is 75% of the story in Russia," says Deutsche Bank's Cassard. "If the oil outlook is benign, with a price in the $20s, [bond investors] will make money." At $10 a barrel, the picture turns much grimmer.
Tariffs on oil exports account for around 30% of total budget revenues. For every $1-per-barrel decrease in the oil price, Russia's $26.7 billion budget loses $400 million in revenues. Even Kasyanov has cautioned against too much ebullience. "Global economic growth is forecast to slow in the next year, and this will be reflected in a decrease of exports from Russia," he recently told lawmakers.BIG SPREAD. Still, some investors find Russia an irresistible gamble. "Russia is an animal that generates returns as far as the eye can see," says Arnab Das, an emerging-market debt strategist at J.P. Morgan in London. "But high volatility comes hand in hand with that." The 30-year Eurobond issued as part of the London Club restructuring is now trading at about 38% of face value for a yield of 17%, a spread of 1,119 basis points over benchmark U.S. Treasury bonds.
But investors like its liquidity, and they're counting on Putin to keep the economy buoyant. "There's certainly a lot of upside to that bond," says Eric Kraus, an economist at NIKoil investment bank. If it follows in the footsteps of Russia's Eurobonds due in 2001 and 2003, holders are in for a lucrative ride. The 2001 bond traded at 30 cents on the dollar of nominal value in October, 1998. Now, it's at 96.75 cents to the dollar. The 2003 bond has gone from 20 cents to 95.8 cents.
If yields remain much over 12% for short-term issues, Russia may shy at the expense and not issue new bonds. But Western banks think the giant nation needs to return to the debt markets to regain credibility. "It makes sense for Russia to come back to the market," says Philip Poole, head of emerging markets at ING Barings in London. "Once [Russia] re-accessed the markets, its ability to manage the rest of its obligation would significantly improve." And as August, 1998, recedes into the past, investors will be waiting.By Catherine Belton in MoscowReturn to top