08/06/1998 23:30:59 FEATURE - Russia's high-stakes game with bond buyers
By Catherine Evans
LONDON, Aug 7 (Reuters) - Russia's so-called debt crisis is not so much
about money, it's about confidence.
The sums involved are huge -- $20 billion worth of domestic debt falls due
before the end of the year -- but the question for the markets is not the extent
of Russia's indebtedness. It is how convincing a confidence game Russia can
The country has just four months to persuade foreign investors -- many of
whom have already lost money backing Russia this year -- to lend it enough cash
to pay off the debt.
The stakes are high. If it fails, Russia will be in default, and the
financial community is unlikely to prove forgiving. If it succeeds, the problem
will be solved -- Russia will have years rather than months to pay back its
"Unlike in many Asian countries, this is a flow-induced problem," said
Jerome Booth, an analyst at ANZ Bank in London.
"Flows do affect fundamentals, but if (outflows) are reversed, the
fundamentals problem disappears. Russia has the potential to rebound pretty
Russian debt prices have plummeted in the last few months as general worries
about Asia-related volatility have combined with specific concerns about
political instability, inadequate tax receipts and a falling oil price to
undermine confidence in the country.
Domestic yields in particular have risen to punitive levels, forcing Russia
to look abroad for money with which to refinance maturing rouble debt.
Russia's plan is to clear its balance sheet of GKOs, the short-dated rouble
Treasury bills which since 1993 have been the government's principal source of
funding. It wants to replace them with lower-yielding, long-dated,
dollar-denominated bonds sold on the international market.
GKO yields are currently around 70 percent.
NO NEED TO INCREASE OVERALL DEBT BURDEN
Russia does not need to increase its overall debt burden, which at less than
50 percent of gross domestic product is relatively low by international
standards. For example, the Maastricht criteria calls for EMU members to have a
60 percent ratio.
Russia used proceeds from two Eurobonds sold in June to pay off maturing
GKOs, and last month completed a unique debt swap which saw $4.4 billion of GKOs
exchanged for two more Eurobonds.
But the massive volume of dollar paper Russia has issued in the past two
months has created problems.
Taken together, the four new Eurobonds total more than $10 billion. That
represents a 40 percent rise in the total stock of Russia's dollar debt, which
includes $29.4 billion face value of rescheduled Soviet-era commercial loans and
$8.7 billion face value of dollar-denominated fixed-rate bonds known as MinFins.
Since the first of these new Eurobonds was launched on June 3, Russia's
dollar debt has fallen to historic lows, and bankers say unsold paper continues
to wash around the market.
On Wednesday, Russia's benchmark 2018 Eurobond was trading at a premium of
1,177 basis points over U.S. Treasury notes, out from 940 basis points when the
debt exchange was completed on July 20.
In November 1996, when Russia returned to the international bond market for
the first time since the 1917 revolution, it paid a premium of 345 basis points
FOREIGN INVESTORS RELUCTANT
Back then, enthusiasm for Russia was high.
Nowadays, foreign investors are showing a marked reluctance to help bail
Russia out -- unless, they say, they see clear evidence the country has started
to tackle its fiscal deficit.
"They need to hold the rouble where it is, and they need to collect taxes.
If they can do that, then Russia would be a very good investment," said Thomas
Bell, investment manager at Templeton Investment Management in Edinburgh.
Brett Diment, a fund manager at Morgan Grenfell Asset Management in London,
said he was positive on Russia's economic fundamentals, but believed the backlog
of dollar paper would not be cleared until positive news on taxes persuaded
foreign investors to reverse sell-orders.
"We've had $10.15 billion of new paper in the last few weeks, while more and
more people have withdrawn from the market. It will take a while for the
technical factors to come clear, but then more people will come in," Diment
Fear of further supply from Russia is also helping depress dollar debt
Russia has said it will sell no more than $2.0 billion more of Eurobonds
before year-end, with a return to the market expected in late October.
But with $12 billion of GKOs to refinance before November, when tax receipts
are forecast to pick up, many expect Russia to undertake another
rouble-for-dollar debt exchange.
"If domestic interest rates stay at current levels, there is a clear
incentive for Russia to do another exchange. That will have an impact on
supply," said ANZ's Booth.
He was sceptical about Deputy Finance Minister Mikhail Kasyanov's assurance
that the exchange was a one-off.
Booth said he believed Russia would seek to exchange another $4.0 billion of
GKOs for dollar bonds, taking the total swapped to more than $8.0 billion --
roughly one-quarter of the outstanding GKO stock, and close to half the amount
maturing before year-end.
MGAM's Diment said he thought an exchange would prove difficult with dollar
paper at current levels, but acknowledged that it made sense for Russia from a
debt management perspective.
But some believe a second exchange is unfeasible.
Because GKOs and dollar Eurobonds are such different debt instruments, they
tend to be purchased by different kinds of investors, who do not regard the two
"We didn't take part in (July's) GKO exchange because we are a
short-duration fund and do not want seven and 20-year paper," said Nick
Davidson, deputy chief executive at WMB Asset Management.
The size of July's debt swap suggested that virtually all those eligible
exchanged their GKOs, leaving the remainder with rouble investors -- mainly
Meanwhile, increased confidence in the rouble following last month's $22.5
billion International Monetary Fund-led financial aid package for Russia has
made swapping roubles for dollars less attractive.
Another disincentive for GKO holders is the simple supply/demand equation
-- as the stock of domestic debt falls, prices should benefit.
Last month's debt swap cut GKO yields dramatically, from a pre-exchange
peak of more than 100 percent to an average of just under 58 percent at the end
of July. Cancellation of new GKO auctions since the exchange was completed has
also buoyed the market.
But international investors remain wary, saying they want to see that
Russian yields are heading lower before they will buy Russian debt securities
"We buy GKOs but they've been up and down like a yo-yo in the last few
months. We have also held Russia's dollar debt, but don't at the moment," said
"I would consider reinvesting if GKO yields came back to the 20 to 30
Increased tax revenues aside, investor confidence is likely to hinge on a
more stable global environment and an increase in the price of oil, Russia's
A rising oil price should help Russia's fiscal balance, as increased profits
will allow hydrocarbon companies to pay off some of the billions they owe in
"People want to see Japan work through its problems a bit more, which will
take a couple of months. By then, we expect the oil price to be higher, which
will help Russia quite substantially," said ANZ's Booth.
"If that's true, big institutional investors will start buying, because
there is fundamental value there."
((Catherine Evans, London Newsroom, +44-171 542 8863, fax +44-171 542 8688,