According to the “The Countering America's Adversaries Through Sanctions Act” (CAATSA), signed by Donald Trump in August, US Treasury will consider banning investments by American residents in Russian debt instruments (OFZ) by February 2018.
#background Based on the Russian Central Bank’s data, the share of foreign investors in Russian debt is currently at its historical high. On October 1st it was 33.2%, which is equal to 2.2 trillion rubles, or $37.6 billion.
Such ban, if imposed, would affect the yield of government bonds and the ruble exchange rate. Elvira Nabiullina, head of the Central Bank of Russia:
“The regulator does not see any significant negative impact on the financial markets in case US sanctions apply to Russian debt.
Possible destructive effect may be compensated by the high demand for such instruments coming from banks interested in highly liquid assets.
The yield of government bonds may hike in the short term, after which the rise will amount only to 30-40 basis points.”
At the same time, market has different opinions. Olga Sterina, head of debt instruments’ analysis at Uralsib, described the negative scenario:
“Even if sanctions will only apply to new issues of OFZ, it will lead to the 10%-decrease in foreign holdings of Russian debt, which is to $200 billion in capital outflow. This sum is quite large for the Russian debt market.
As a result, the ruble will depreciate by 15% (to the level of 68.3 rubles per dollar), which may force the Central Bank to raise the key rate. According to our estimates, at the peak of the sell-off the yield may reach 9.5-9.7% – a hike of 200 basis points.”
However, analysts of Raiffeisenbank say that market reaction will be determined by the composition of OFZ holders:
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“Among the investors affected by the ban, may be Russians who buy OFZ through offshore jurisdictions. Therefore, this category of investors is unlikely to sell their share of Russian debt.
Moreover, the inflow of foreign capital in Russian debt keeps growing – it constituted $12.6 billion in the first 9 months of 2017 against $8.2 billion in the same period last year.
Under these conditions the impact of sanctions on the yield curve will not be so significant.
Based on the comparison of the OFZ market before and after its liberalization of 2012-2013, the final effect of sanctions may be around 2 basis points, if the Central Bank does not intervene.”
How Russian government may minimize the damage
Analyst emphasize several possible strategies Russia might take to avoid the grim consequences of sanctions against its debt.
1st strategy (the most likely). Central Bank of Russia may start a massive bond-buying programme. Raiffeisenbank:
“To mitigate the effect the sell-off would impose on OFZ market, a stable local buyer would have to emerge. We think that, in this case, interventions from the regulator will be the best fit for that role.
Russian state-run banks may join the Central Bank in saving the OFZ market. But this would imply a higher debt burden and interest rate risk for them, while the carry would remain negative.”
2nd strategy. Central Bank and Ministry of Finance may issue bond denominated in yuan to attract Chinese investors. This option has been in talks since 2015, but the decision was rescheduled to 2017.
Sergey Storchak, finance vice-minister, on November 10th announced Ministry’s plans to hold a meeting with Chinese investors on the topic.
3rd strategy. The government may promote domestic demand for OFZ. Ealier the Ministry of Finance announced plans on attracting 4.7 trillion rubles in domestic investments throughout 2018-2020.
Reuters: Ministry of Finance intends to popularize the special issuance of OFZ aimed at ordinary people (community OFZ) by making them more appealing to investors. Allowing for the secondary market and lifting the ban on the maximum amount held by one investor (currently 15 million rubles) are among the options.
#background In 2017 the Ministry of Finance placed three community-bond issues of 15 billion rubles each and 8.5% yield.
If the rates on deposits keep falling, additional amount of domestic investments may flow to OFZ.
4th strategy. The government may place more eurobonds abroad. Andrey Hochrin, head of the department of wealthy client service at “Zerich Capital Management”:
“We have an excellent record of issuing sovereign eurobonds even after the sanctions take place.”
#background In 2016 Russia raised funds on the international debt market for the first time in three years, placing two issues ($1.75 billion and 1.25 billion) of bonds due in 2026. The law that guides the Russian budget in 2018-2020 assumes issuing $7 billion worth of eurobonds every year.
Also published on Medium.