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Banking & Finance

RUSSIA INDIA BUSINESS REPORT

IN ASSOCIATION WITH ROSSIYSKAYA GAZETA, RUSSIA

THE ECONOMIC TIMES WEDNESDAY_MAY 12_2010

BOOKMARKS

en.rian.ru/business RIA Novosti newswire www.businessneweurope.eu Stories on businessin Eastern Europe and the CIS www.minfin.ru/en Ministry of Finance of Russia

Borrowing Foreign cash waits in the wings as Russia launches its first Eurobond issue in 12 years

Kudrin invites investors to a big, new bonding session

Keen international interest in Russia's Eurobond issue points towards an underrated economy with strong fundamentals.

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Russia made a sparkling re- turn to international credit markets with its first sovereign Eurobond issue in 12 years to raise a total of $5.5bn - the sec- ond biggest dollar issue on re- cord. What a difference a decade makes! The Russian govern- ment was forced to default on its international debt in the wake of the financial crisis that swept the country in the sum- mer of 1998, costing interna- tional holders of its bonds some $40bn in losses. However, investors were champing at the bid to get a piece of the action this time round with the offer at least three times oversubscribed with record low yields for a Russian bond. On April 22, Russia sold $2 bn worth of five-year bonds and $3.5 bn in 10-year bonds. In terms of pricing, the five- year portion pays a coupon of 3.625 pc and spread of 125 basis points over US Treasur- ies, while the 10-year tranche pays a 5 pc coupon and spread of 135 basis points over Trea- suries. The world has been turned up- side down by the crisis. While Greece is sagging under heavy public debt, Russia not only has almost no debt to speak off (Capital Economics predict 9.5 pc of GDP by the end of this year), but also has well over $400 bn in hard currency re- serves. That’s five times more than either the USA or Brit- ain, making it the third richest country in the world in terms of cash. While Greece will struggle to pay off its bonds as it stag- gers under a 12 pc budget deficit, Russia has $24 in cash to cover each dollar the government plans to borrow. Russia is enjoying a mirror image of the problems its more developed peers are facing. For example, Britain is one of the most indebted countries in Eu- rope after it borrowed a mas- sive $245.8 bn last year, ratch- eting up its debt against reserves. America is in similar dire straights. Nonetheless, Russia’s pubic fi- nances are still under pressure. It needs to finance a budget

deficit that will come in-be- tween 3 pc and 8 pc (depending on the price of oil) and needs to raise funds to get it through this lean patch. Russia’s finance officials are planning a tour of Asia, Europe and America to promote Rus- sia’s first Eurobond sale since 1998 – 12 years after it default- ed on its bonds during its last big crisis – and they are confi- dent that they will be able to tap the markets for relatively cheap money. “Borrowing terms will likely be very advantageous,” finance minister Alexei Kudrin told reporters earlier this month. The market understands that Russia is able to borrow do- mestically if the terms aren’t, “extremely favourable”. “Kudrin is right to be confi- dent,” says Liam Halligan, chief economist with Prosper- ity Capital Management. “Since taking office in May 2000, he has built a massive re- serve base and paid off almost all sovereign debts. Russia is launching this Eurobond as one of the world’s most fiscally secure nations – a reality likely to cause mainstream Western investors to reassess a range of Russian assets.” Kudrin has the authority to borrow upto $17.8 bn, but as oil prices breached the $85 per barrel level at the start of April, money is starting to pour into the country and most experts

Optimism grows, unemployment rates dip

CONTINUED FROM PAGE 1

The economy is creaking back to life as retail sales also rose for the third month in a row, up 2.9 pc over the first three months of the year, the State Statistics Service said Retail sales were up only 0.9 pc in February. "For the next few quarters, the downward unemployment trend and signs of a pick-up in bank lending point to stronger domestic demand; also, the ex- ternal growth outlook is im- proving," says Anna Zadorno- va, an economist at Goldman Sachs.

Russian finance minister Alexei Kudrin has been given a free hand to borrow billions of dollars abroad

16.6

Ukraine

12.5

Hungary

SOURCE: BLOOMBERG

P/E comparison emerging markets

The price/earnings ratio measures a company’s stock value against its earnings. The lower the ratio, the better value a stock is seen to be.

8.1Russia

National average: 14

expect Russia to borrow half or even a quarter of this amount. The price of the bond will high- light the overly cautious stance of most rating agencies on Rus- sia. Currently, Russian sover- eign debt has a BBB rating, which is only three notches above junk-bond status. At the same time, the US and Britain have (so far) kept their AAA ratings, despite their worsen- ing situations. Most economists are predict- ing Europe’s external debt to rise from 100 pc of GDP to 130 pc over the next five years, while that of Russia is expect- ed to start falling. Analysts say that the ratings of developed countries have disconnected with reality, while countries such as Russia are being pena- lised. “On the basis of our model, the [best possible] AAA rating for the US and Britain cannot be explained, as these two coun- tries are rated two to three rating notches better than countries with comparable fundamental data,” Ingo Jungwirth, an analyst with

Raiffeisen International wrote in a study in March. This study found that, based on the country’s finances, both the USA and Britain should be downgraded three notches to a simple AA. However, if the rat- ings agencies actually went through with a downgrade, the cost of borrowing to both coun- tries would spike, sparking a financial crisis that could wreck the global economy for decades. Jungwirth suggests that these two countries earn a

“bonus” for being too big to fail. On the flip side, Russia is un- derrated given the strength of its financial position. Consider that on the day Iceland de- faulted on its debt at the start of this crisis it enjoyed higher ratings than Russia. Today, Russia’s BAA1 rating from Moody’s is still the same as bailout-dependent Iceland’s. Fitch and Standard & Poor’s currently class Russian debt as BBB – even lower than Moody’s. “These ratings seriously un- derstate Russia’s ability to ser- vice and repay its debts,” says Mr Halligan. “Some say they reflect the risk that Russia might ‘choose to default’. “Yet Russia’s political elite was traumatised by 1998; Kudrin, with the blessing of successive

premiers, has spent 10 years trying to rebuild his country’s fiscal reputation. The idea of a deliberate default is absurd.” There are already signs that in- vestors are cottoning onto the strength of the Russian bond offering. After US investment bank Lehman Brothers col- lapsed, the spreads on British credit defaults swaps – a kind of insurance against bond de- faults by the issuer – have soared by 281 pc. “The government isn’t issuing the bond to raise money. It al- ready has plenty of money,” says Mr Halligan. “The main reason they are issuing the bond is to draw attention to the Russian economy, force the government to explain its re- form agenda better and help ‘decontaminate’ Russia as a place to do business.”

Russia versus the West: credit default swaps

5-year spread (basis points)

Russia

Portugal Ireland Italy

Greece Spain US UK

Iceland

176.9

165.2 144.3 129.6 369.1 130.1 45.7 86.5

525.3 (March 1, 2010)

Since Lehman Brothers collapse (change in pc)

-17

+270 +319 +176 +550 +195 +117 +281 +90

SOURCE: BLOOMBERG, PCM

Credit default swaps measure the market's interest in bond in- surance. The higher the number, the more likely the country – as viewed by the global market – is to default.

Companies are adding workers because of mounting confi- dence that demand and profits will continue to improve. Man- ufacturers cut jobs in March at the slowest pace since Septem- ber, while employment in ser- vice industries stabilized and was unchanged from February, according to purchasing man- agers' indices published by VTB Capital. "Domestic demand is finally re- bounding," Alexei Moiseyev, a senior economist at Renais- sance Capital, wrote in a note on April 12. Renaissance Capital raised its second-quarter growth outlook to 8.3 pc from 7.9 pc in April on the back of rising domestic de- mand while predictions for the size of the budget deficit at the end of this year have fallen from 6.8 pc of GDP to a bit less than 2 pc now. With the economy bouncing back more strongly than ex- pected, Putin in his annual re- port chose to focus more on a raft of long-delayed social ini- tiatives designed to provide better social support to the pop- ulation and generally improve people's standard of living. Putin said that the healthy state finances (Russia remains the third richest country in the world in terms of cash in the bank) allowed the government to move swiftly to avert the worst shocks of the financial crisis without the need for ex- ternal funding. Despite a sharp drop in reve- nues last year, budget spending was not cut, and part of the out- lays were redirected towards social spending, Putin said. He used the speech to announce that the state was going to build 11 state-of-the-art hospital fa- cilities around the country and his comments follow those of Deputy Prime Minister Sergei Ivanov who announced earlier that starting from this year, Russia would "spend more on education than it does on its military," or 4.4 pc of GDP. Putin also announced that the health insurance contributions of employers would go up at the start of next year by 2 percent- age points to 5.1pc.

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