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From Black Hole To Blue Chip


It was one of those statements that everyone remembers decades after the event. The year was 1998, Russia had defaulted on $40 billion in domestic debt, and foreign investors who were heavy buyers of those bonds were licking their wounds. An angry banker declared that Westerners would "eat nuclear waste" before sinking money into Russia again.

Just six years later, Russian bonds are again a hot property, Moscow is considered one of the world's most reliable borrowers, and two of the three international rating agencies have given Russia an investment-grade seal of approval. Among Russia's biggest cheerleaders? Western investors.

On Nov. 18, London-based Fitch Ratings upped its long-term rating for Rus-sian government bonds by one notch, to an investment grade BBB-. That came a little more than a year after Moody's Investors Service also raised Russia's bonds to investment grade. "Russia has turned in a phenomenal macroeconomic performance, surpassing our bullish expectations," Edward Parker, Fitch's lead Russia analyst, told investors in a conference call on Nov. 19.

It's no secret, of course, why Russia's fortunes have turned around so dramatically. Oil and gas account for 55% of Russia's exports -- and with oil prices around $50 a barrel, the country is raking in petrodollars as never before. In 1998, when oil averaged just $13 a barrel, the country earned $14.5 billion from black gold. This year, with production bolstered by huge investment and rising prices, it is expected to pull in $78 billion. Moscow's foreign-currency reserves now total $113 billion -- a ninefold increase since the end of 1999 and a comfortable cushion against any new crisis.

But if Russia has been lucky, it has also made the most of its luck. In the past five years, President Vladimir V. Putin's economic managers, led by Finance Minister Alexei Kudrin, have taken full advantage of their oil and gas windfall to get government expenditures in hand and fashion a functioning tax system. "Kudrin has delivered a first-rate fiscal policy. It's under his watch we've gone from being a bankrupt nation to an investment-grade net creditor," says Al Breach, chief economist at Moscow investment bank Brunswick UBS (UBS).

BIG CUSHION

The sea of oil has allowed Russia to reduce its foreign debt from almost 100% of gross domestic product in 1999 to about 32% today. Fitch predicts general government debt will fall to 25% of GDP by the end of the year, well below the 40% benchmark it considers normal for a BBB rating. Meanwhile, Kudrin is socking away surplus oil revenues in a newly created "stabilization fund" designed to protect the budget against a fall in prices. The fund has already accumulated $19 billion.

Of course, not all the financial news from Russia is positive. Putin's deliberate destruction of Russia's biggest oil company, Yukos, has had investors wringing their hands. And while economists give Russia high marks for fiscal management, they're less flattering when it comes to structural issues such as banking reform and deregulation. "It's a well-managed oil story, rather than a reform story," says Peter Westin, chief economist at Aton Capital, a Moscow brokerage.

These concerns explain why the third major rating agency, Standard & Poor's (MHP), has so far held out against giving Russian bonds an investment grade. While Fitch's announcement is encouraging, an upgrade from S&P is far more important because the key benchmark for international bond investors, the Lehman Aggregate Bond Index, requires investment-grade ratings from Moody's and S&P before a country's bonds can be included. Large U.S. institutional investors such as pension funds and insurance companies track the Lehman index. These investors may not have long to wait. Russia's financial situation is so solid that analysts are convinced an S&P upgrade is just months away.

By Jason Bush in Moscow


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