Supported by low interest rates and an ever-expanding pool of investors, Russias local bond market continues to grow. But with interest rates rising, is the deep pool of money that flooded the market last year in danger of drying up? Joanne OConnor reports.
Bigger, longer and more liquid: Russias local bond market has continued to grow apace, giving borrowers ever cheaper access to funds and investors an array of borrowers unimaginable in the Eurobond market. Last years decision by the Russian authorities to liberalise the rouble has had far-reaching consequences for the countrys local bond market.
"The distinct features of Russias local bond market remain its rapid growth and improvement in terms of trading liquidity and investor base," says Stanislav Ponomarenko, a credit analyst at ING in Moscow.
According to figures from Micex, the market for corporate and regional bonds is growing rapidly and its share of the total exchange turnover reached 12.5% in the first quarter of 2007, more than double the total trading volume for the same period in 2006. Of this, there were Rb1.55tr of trades in corporate bonds, well ahead of the Rb16bn of trades in regional bonds and Rb16bn of trades in municipal bonds. Unsurprisingly, the most actively traded bonds are also the largest deals from top borrowers including Russian Railways, Gazprom, and Lukoil.
"Liquidity is improving all the time," says Ponomarenko. "Daily trading volumes regularly reach $500m, suggesting that over a year, bonds may change hands two to three times."
In the first quarter, 44 new corporate bonds were launched, totalling Rb110bn. The growth is at least in part thanks to the federal governments shift from international to local borrowing, but this aside, the corporate bond market has grown by an average of 80% over the last four years and in the last two years, has doubled.
Investor base growing
Long restricted to local banks with limited appetite for large, longer dated deals, the investor base for Russias local bond market is rapidly expanding as international names pile into the market and the easing of investment restrictions on the countrys pension funds enable them to invest in riskier and less liquid deals. But the dominance of local banks remains a big source of volatility in the rouble bond market as yields skyrocket on every banking liquidity crunch.
"It is still the case that local banks are prominent, but the proportion of local bank participation has fallen from 90%-95% to between 65% and 70%," says Nikita Riauzov, head of investment banking at MDM Bank in Moscow.
Helped by strong oil prices and the removal of currency restrictions in 2006, the rouble appreciated by more than 7% against the dollar last year making Russias local bond market an attractive place to obtain the dual benefits of currency appreciation and bond coupon. While bank borrowers comprise around a third of Russias local bond market, the local market also offers international investors access to second and third tier names not active in the Eurobond market. In particular, Russias retailers are found in abundance in the rouble bond market but rarely issue bonds internationally.
Although they remain clustered around first tier names and deals, says Ponomarenko, "the range of securities in which the pension funds can invest is still quite limited and based on credit quality and liquidity. But restrictions are being loosened allowing pension funds to invest in a wider array of deals."
Borrowers are also enjoying a greater range of options in maturity, size and structure. For example, the floating rate market took a step forward this year when juice and baby-food company Lebedyansky became the first corporate borrower to issue a floater note using the MosPrime rate. The Rb1.5bn deal was led by Raiffeisenbank Austria and attracted Rb3.8bn of orders and was priced at 143bp over the MosPrime rate, making the first coupon 6.86%.
And in January and February, after months of anticipation, Clearstream and Euroclear, the rival European clearing and settlement organisations, added the rouble to their list of settlement currencies. The moves sparked a swathe of rouble denominated issues from triple-A rated borrowers which were followed by Gazprom and Ursa Bank.
"For borrowers who want to attract substantial funds and broaden their investor base, this structure is a breakthrough," says Ponomarenko.
"Its still not easy to raise the equivalent of $500m in the local market and for many local companies, it is more convenient in terms of forex risk, to place internationally in roubles."
Liquidity drying up?
As expectations of rouble appreciation have eased back and with interest rates rising, the deep pool of liquidity that flooded the market last year is looking slightly shallower in 2007. Overnight interest rates, the prime indicator of the cost of Russian debt, were at 1%-2% in 2006 but are today averaging 2.75%-3%. At 0.6%, March inflation figures were lower than the forecasted 0.7% and altogether, inflation is 1.5% lower this year than it was at this time in 2006. Nonetheless, some in the market predict overnight rates will rise to up to 5% or 6%.
"Last year the market was so overliquid that investors bought anything even at yields lower than inflation," says Riauzov.
"The cost of funding is higher this year and investors are more cautious about risks and are looking more closely at risk."
For the third tier assets illiquid bonds issued by the highest risk credits many bankers predict 2007 may be the year when defaults start to seep into the market.
"Some of these third tier borrowers will not find it as easy to refinance as they did before," says Riauzov.