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Online Extra: "A Huge Appetite" for Russian Bonds


Not a single Russian company rates investment-grade status. But that isn't deterring foreign investors from pouring money into Russian corporate bonds. Mutual funds, insurance companies, and other institutional investors from Europe and the U.S. bought an estimated $3.5 billion worth of fixed-income securities issued by Russian companies last year, almost six times as much as in 2001.

And this year, predict analysts, they could buy up to $6 billion more. "Russian paper has become extremely popular," says Jerome Booth, head of research at London-based Ashmore Investment Management, which specializes in emerging markets. "There's a huge appetite for it."

At the same time, international banks have been lending heavily to companies from St. Petersburg to Vladivostok. According to the Central Bank of Russia, they lent more than $5 billion last year, three times as much as in 2001. CBR economists expect them to do just as much, if not more, this year. All told, they say, Russian companies now owe around $31 billion to Western investors and banks. That could rise to $34 billion by yearend -- twice as much as at the end of 2001.

NEW PERCEPTIONS. Just two years ago, only a handful of Russian companies had enough credibility to raise money on the international capital markets. The financial crisis that erupted in August, 1998, when the government defaulted on $43 billion of ruble-denominated bonds, destroyed investors' confidence in the creditworthiness of even the biggest and best-managed Russian companies. But since then, investor perception has made a remarkable turnaround. More than 20 companies -- including gas giant Gazprom, carmaker Avtovaz, and fruit-juice and dairy-products company Wimm-Bill-Dann -- now actively sell bonds on Western capital markets, and yield-hungry investors don't seem able to get enough of them.

The $840 million euro-denominated bond that Gazprom unveiled on Sept. 15 has seen so much demand that it's considering increasing the offering to $1.12 billion. "The issue has already been many times oversubscribed," says Gazprom deputy Chairman Boris Yurlov. "Demand has been extremely brisk."

Investors are being attracted to Russia anew because of its strong economic performance in recent years. Gross domestic product growth has averaged more than 5% a year since 1999. They also like President Vladimir Putin's economic policies, which have boosted tax revenues, strengthened government finances, fortified shareholder rights, and improved corporate governance. At the same time, many Russian companies -- especially those involved in the energy-rich country's oil and gas sectors -- have boosted foreign currency earnings and overall profitability. "They are mostly very solid risks," says one foreign Moscow-based investor. "These companies can easily service their debts."

MORE MONEY ABROAD. At a time when interest rates in Europe and the U.S. are at their lowest levels in two generations, investors also like the hefty returns they get here. Most Russian company debt still yields more than 7%. Even this summer's scandal at oil giant Yukos, whose CEO Mikhail Khodorkovsky was alleged by government officials of having acquired state-owned property illegally, didn't dim investors' enthusiasm for long -- even though it generated speculation that Putin was preparing to renationalize some privatized assets.

For their part, Russian companies prefer to raise money through bond issues or bank borrowings rather than bringing in foreign shareholders. That's because their existing investors don't like the idea of sharing control with those overseas. Companies also prefer to tap the foreign currency markets because they can raise money for longer than they can domestically.

In any case, there just isn't enough money at home to meet their needs. The Russian banking system's total assets don't amount to much more than $100 billion, little more than the balance sheet total of a single midsize European or American bank.

UNLIKELY SCENARIO. To be sure, lending to Russian companies remains risky. If energy prices fall, the profitability of the oil and gas exporters would be squeezed, and overall economic growth would slow. Another danger is that the general election due in December could produce a parliament that's hostile to the further economic reforms that are needed to sustain the recent burst of economic growth. And some analysts worry about weaknesses in the domestic banking sector, which they say could hold back future growth and sap corporate earnings.

However, only the gloomiest of Russia-watchers think another default is in the cards. On the contrary, they expect the rating agencies to upgrade the country, and many companies, to investment grade in the near future. If that happens, so much money could flood in that the recent inflow will look just like a trickle. By David Fairlamb in Moscow


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