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Thursday, 23 November 2017

CEE 2006 - Too much money, too few quality assets

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The Russian domestic bond market is through its infancy, but before it can reach fully-fledged adulthood, tenors and deal sizes need to increase. This is starting to happen. The City of Moscow – which aside from the Federation continues to be the leading and benchmark issuer – has already pushed tenors out to 10 years. Richard Jory reports.

The City of Moscow completed its latest issue, a 10-year, on April 12. "Interest rates were rising in the domestic market, but we still managed to place a 10-year issue at a rate of 6.90%. With inflation at 11-1/2%, it shows the demand for good quality assets," said Sergey Pakhamov, chairman, Moscow State Debt Committee.

Although obviously pleased with the outcome, the result was not necessarily good for the development of the market. "There is too much money chasing too few quality assets. We need economic growth on the basis of investment not consumption," explained Pakhamov. "If you had asked two to three years ago whether 10 or even 15-year bonds in roubles would be possible, I would have said no," said Pakhamov.

Other issuers have sold bonds at levels below inflation and this is expected to continue. "As long as there is the current liquidity, this trend could continue for some time," said Michael Discher-Remmlinger, head of emerging market portfolio management at Pimco in Germany.

Despite a continued reliance on the energy sector as the dominant income and profit generator, there are signs that the financial community is seeking to address the relative health of local companies in other sectors. State-owned Vneshtorgbank (VTB) has outlined its support for lending local currency funds to sectors other than energy. "Russia is still an under-leveraged country," said Nataly Loginova, vice president and head of financial institutions at VTB.

In terms of its own funding, VTB's decision to issue the first public rouble-denominated Eurobond was welcomed by international investors but left some market observers questioning the loss of supply from a domestic market that is still developing.

Further handicaps to the growth of the domestic market include the relatively small issuance demands from Russia's biggest company, Gazprom. In previous years, the oil and gas giant had a regular issuance pattern and its issues were considered alongside City of Moscow bonds as benchmarks. Although Gazprom issued domestic bonds last year, it has embarked on a strategy this year which skews its fundraising to the international and loan markets.

For Gazprom, the issue lies with the depth of a market which until recently had little to offer in terms of tenor. That said, the company's balance sheet is heavily weighted towards foreign currency both in terms of income and expenditure, meaning that a rouble-based market is not a match for any new cash or refinancing needs.

Other regions – Moscow Oblast apart – have also failed to exploit the local bond market. "The City of Moscow will keep its dominant position in the Russian local fixed-income market (as the second largest issuer after the Federation)," said Pakhamov. "We will be looking to extend tenors. We have another Rbs40bn-Rbs45bn to raise in the domestic bond market this year and our dominance will increase, although I would rather see more competition from the Regions."

As in the international bond market, those tending to rely on the domestic market for funds include a hefty supply of banks: Russian Agricultural Bank, Russian Standard Bank, International Moscow Bank, Bank Zenit, Gazprombank and AK Bars Bank have already sold bonds this year. The yields for these bonds have ranged between 7.85% and 8.39%, still lower than the rate of inflation.

And there are more banks to come: Sibacadembank is lining up three new issues, and Gazprombank, Moscow Bank of Reconstruction and Development, and MDM Bank all looking to issue in the coming months. While this provides a healthy pipeline, the question of issuer quality has been raised.

The banks will thrive only as long as the Central Bank holds back from using interest rates to deal with relatively high inflation. Investors that have questioned the lack of an interest-rate policy specifically aimed at attacking high inflation have been met with an answer that calls the quality of the whole banking (again) into some doubt. "The credit fundamentals have not improved for the economy," said Discher-Remmlinger. "We fear the banking system would not survive a raising of interest rates as a strategy to combat inflation."

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