Putin: concerned
about inflationRUSSIA’S SOVEREIGN presence on international debt markets is getting smaller and smaller but Russian corporate debt is a rapidly growing sector. CSFB’s debt capital markets team recently undertook an analysis of the market, finding that Russia’s corporate Eurobond debt is now worth as much as $30 billion, accounting for 57% of the total Russian debt market. That makes it bigger in absolute terms than the corporate Eurobond volumes of most other emerging markets. Of that, about 60% is debt issued by state-owned companies, such as Gazprom, Sberbank and Vneshtorgbank. Sofia Sool, vice-president of debt capital markets at CSFB, says: “Issuance by these entities is increasingly being taken by investors as a proxy for sovereign debt. As the amount of sovereign debt gets smaller, the demand for their debt gets bigger.”
The volume of Gazprom Eurobond new issues, for example, rose from $2.7 billion in 2004 to $5.3 billion in 2005, including $1 billion in new issues by Gazprombank. Spreads on Gazprom’s 2013 issue tightened by 120 basis points in 2005. Vneshtorgbank’s new Eurobond issuance rose from $1.6 billion in 2004 to $2.4 billion in 2005.
State-owned issuers have been able to issue at longer tenors, in greater amounts and via more complicated structures, such as subordinated debt deals or securitized transactions. “They’ve certainly been borrowing more this year,” says a London-based head of emerging-market syndicate. “That’s in part because of the excellent financing environment, with so much investor demand for emerging-market debt.”
In the syndicated loan market, state-owned companies have also been issuing major deals. Vneshtorgbank, Gazprombank and Sberbank vied with each other throughout 2005 in issuing jumbo loans, with Gazprombank raising $650 million in April, only to be outdone by a $1 billion loan raised by Sberbank in November, at a rate of Libor plus 55bp.
Even that deal was dwarfed by the syndicated loans raised by the big energy companies. Rosneft signed a $7.5 billion deal with western banks in September to fund the state’s acquisition of 10.7% of Gazprom. Then, in late November, Gazprom raised a $13.1 billion loan from foreign banks to buy Sibneft from Roman Abramovich – the largest emerging-market corporate loan ever.
The government is getting increasingly concerned about the size of these commitments. In late November, minister for economic development and trade German Gref suggested to president Vladimir Putin that the government should set limits on state companies’ foreign borrowing. His remarks were echoed by deputy finance minister Alexei Savatyugin. “It is time to think about whether it is worthwhile to build up this foreign debt,” he said.
Rating agencies are also beginning to express concern. Moody’s sovereign analyst Jonathan Schiffer, even as he raised the sovereign rating from Baa3 to Baa2 in October, said Russia needed “to monitor and perhaps issue guidelines for the rapidly growing foreign-currency borrowings of major quasi-sovereign corporations”.
Expansion of state role
International banks, for which quasi-sovereign debt has been a good source of income, express surprise and concern at the government’s plans. “Why would they want to do that?” asks one syndicate head.
For several reasons. First, there is the threat of contingent liability. Raphael Morechal, a senior fixed income investor at Fortis, says: “Most investors assume that the government would step in to support the big state-owned companies. Gazprom is too big to fail, for example, and Vneshtorgbank is of systemic importance to the banking sector.”
If the economic environment suddenly deteriorated because of a fall in oil prices, and state companies had trouble with their debt servicing, it would be much easier for the government to bail them out in roubles than in dollars. The government has already placed limits on the foreign borrowing of Russia’s regions, precisely because it had such difficulty in bailing them out in 1998. Regions can now only refinance existing foreign debt on the international markets. The state also stepped in to prevent Transneft from issuing on the foreign debt markets in 2003, obliging it to raise a loan from Sberbank instead.
Second, the ministries of finance and of economic trade and development are concerned that the inflow of billions of dollars into the economy from the international debt markets is exacerbating inflation, leading to hot money in the local capital markets and pressure on the rouble to appreciate.
Inflation
The government set an inflation target of 8.5% this year but inflation looks set to stay stubbornly at the 11% to 11.5% level. Gref remarked to president Putin in late November, in a televised cabinet meeting: “If oil prices remain very high, we shall have to take additional measures.” The plan to limit state companies’ foreign borrowing is one part of Gref’s anti-inflation package, which focuses on lowering inflation while resisting further rouble appreciation [see A way to lower inflation, this issue].
Third, both Gref and Kudrin are concerned that state companies are going on a debt-funded acquisition spree, with damaging consequences for the economy. Rosneft bought Yuganksneftegaz, funded with debt from Chinese banks, in December 2004. Gazprom bought Sibneft in November 2005. UES bought Power Machines in the summer of 2005, again via a foreign loan. Vneshtorgbank bought Guta Bank in 2004, and PromStroiBank and some small banks in the CIS in 2005. It hopes to buy Moscow Narodny Bank and other banks this year. The state looks set to acquire a significant stake in car manufacturer AvtoVaz, and rumours suggest it could even buy Norilsk Nickel, via the same state-backed leveraged buyout mechanism with which Gazprom bought Sibneft.
The state’s influence in the economy is thus obviously expanding, even though the Gref economic doctrine of 2000 says that it should shrink. Gref has repeatedly criticized expansion of state activity, which he says is inefficient and deters private investment. Putting a limit on state companies’ foreign borrowing could be a way of curbing this expansion.
The plan would have significant consequences if it came into effect. First of all, state companies would be forced to raise debt only on the local bond and loan markets. This would mean raising about $20 billion domestically. The focus of activity for both bookrunners and possibly foreign investors would then shift to the rouble bond market. On the other hand, the better-rated private sector issuers on the Eurobond market could well receive a boost, as emerging-market hard-currency investors look for a new place to put their money.
Hard to effect
What do the big state borrowers think of the plan? Gazprom, which would be most affected, declines to comment on the policies. Other borrowers express caution. Denis Ursulyak, senior vice-president at Vneshtorgbank, says: “It’s fair that the government wants to monitor the structure and amount of external borrowing by the state and state entities.” But, he adds: “It is sensible to do this by economic rather than administrative measures.”
Rather than setting legal limits on foreign borrowing, similar to those put in place for the regions, Ursulyak suggests “a step-by-step approach” whereby the government increases its monitoring of state entity borrowing via its seat on the supervisory board of state companies. It should insist on companies’ borrowing strategies being approved at this level – as is already the case with Vneshtorgbank. And then companies should be slowly encouraged to shift towards greater rouble bond issuance.
Most analysts believe it would not be possible for the local markets to support an additional $20 billion in debt. Alexander Kudrin, fixed income analyst at UFG, says: “Gazprom couldn’t meet its financing needs domestically. It has already reached its credit limit for all the big Russian commercial banks.” Ursulyak says: “The rouble bond market is growing but it’s not yet big enough to meet all state entities’ financing needs.” He points out that it is also more expensive for a borrower to borrow on the rouble market, so it “wouldn’t be in the interests of the government as a shareholder”.
Rouble bonds
However, the big state borrowers say they are already making the shift into issuing more of their debt in roubles. In October, Vneshtorgbank issued a R15 billion ($517 million) eight-year bond, the biggest one-off rouble bond transaction so far. Ursulyak says: “It’s certainly our plan to do more borrowing in rouble bonds. The ratio of rouble to dollar debt in our portfolio rose in 2005, from 5.7% to 11.4%, and will probably do so in 2006 as well.” The bank is planning to issue a R15 billion 10-year deal early this year.
Banks that work with Gazprom’s debt team says it also plans to issue more in rouble debt in 2006, having issued a R5 billion benchmark in 2005.
State-owned Russian Railways issued a total of R35 billion in a four-tranche deal at the end of 2005, two in November and two in December. Lead managers were CIT Finance and JPMorgan. Ivan Suzimov, director of capital markets at CIT Finance, says: “Taken together, it’s the biggest bond issue ever in Russia.” Suzimov says the market is developing quickly. The average deal size is now up to about $70 million, and the average duration is up to five years.
Foreign investors are beginning to participate in the market, particularly for issues from high-grade names such as the City of Moscow, whose shorter-term deals sell as much as 80% to foreign investors.
Economists say the further development of the local debt markets would be positive for the economy as a whole. John Litwack, the World Bank’s chief Russia economist, says: “The domestic debt market needs to be larger. If there are more domestic bonds, then the central bank has more ability to influence the inflow of funds via rate actions.” At the moment, the economy is to a certain extent at the mercy of the US Federal Reserve, because so much of its debt is in dollars.
Will the government forbid foreign borrowing by state companies? It seems unlikely. Alexander Kudrin of UFG says he thinks the government’s comments were “more of a warning shot” from the Kremlin. However, it seems clear that the government will encourage greater rouble borrowing, and that the market is already shifting in this direction.
It also seems that if Gref’s anti-inflation package doesn’t work, the government might be forced to let the rouble appreciate. This would also be good news for the rouble bond market, as it would attract more foreign investors. Fortis’s Morechal says: “The rouble bond market is getting more and more interesting for us. We expect to see rouble appreciation of 5% to 10% in 2006.” Therefore, while 2006 might be the year of the foreign IPO for Russian companies, it might also be the year of the domestic bond.
