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Russia's $3 Billion Eurobond Offering Proves Sanctions Are Pointless

As Russia Insider predicted Russia is fully able to cover any shortfall in its budget by borrowing - as it is about to show by floating a $3 billion Eurobond

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This post first appeared on Russia Insider


Back in January, in a discussion of oil prices, I said fears of a crisis in the Russian budget are groundless.

If the Reserve Fund ever runs out, and if Russia really does have to fund a budget deficit without being able to draw on the Reserve Fund, it can simply borrow the money to cover the shortfall - something all governments do when they find themselves in such situations - which they all do from time to time.

Russia’s exceptionally strong financial position - with a strong government committed to keeping the deficit low and under control, very low levels of government debt, large foreign currency reserves, a big trade surplus, an abundance of natural resources, and a good recent history of paying debt on time despite the oil price fall and the sanctions - means it should have no difficulty doing so.

I also pointed out that the sanctions do not actually prohibit Russia from borrowing in the international financial markets, and that it is questionable whether it is even legally possible - short of declaring war - to prevent it doing so.

I also expressed the opinion that Russia would have no difficulty finding buyers for any bond issue despite the sanctions.  

Indeed I speculated that because of the very strong financial position and the likely high interest rate, any bond issue Russia floated in the international financial markets would probably be heavily oversubscribed.

When I said those things back in January I did not expect them to be tested - and proved true - so quickly.

In the event, within weeks of my article appearing, Russia announced its intention to float a $3 billion Eurobond issue.  

It seems the US government has indeed tried to block this issue by warning US banks that though the issue is not actually prohibited by the sanctions their involvement in it might be “contrary to US foreign policy”.

Whilst it seems some US banks have heeded this warning, it appears others are not doing so, and the Russian Finance Ministry says it is having no difficulty finding partners amongst the major international banks to help it with the bond issue.

As part of what looks like a campaign to derail the bond issue, stories have appeared in the Western media claiming it is a device to circumvent the sanctions, with the Russian government supposedly planning to cascade money it borrows in the financial markets down to Russian companies in need of funding which cannot fund themselves in the markets because of the sanctions.

This is nonsense.  Quite apart from the fact that doing something like that would be the one guaranteed way of scaring off Western buyers from future bond issues, it would mean the Russian government is willing to take on the foreign debt of Russian companies onto its books, thereby transforming their debt into sovereign debt.  

Anyone with any knowledge of the way the Russian government does its business would know that is inconceivable.  Given the exorbitant cost in interest payments to the country’s budget of doing such a thing, there is no possibility anyone in the Russian government is considering it, since it violates the fundamental principles of sound budgeting and financial management upon which the Russian government runs its budget. 

Besides, the increasingly strong financial position of Russian companies makes such a thing unnecessary.

As to why the Russian government is issuing a bond issue at this time when it in fact has no need to do so, this is for once intelligently discussed in an article by The Economist which I attach below.

Briefly, the Russian government wants to show the world that it can fund its budget by borrowing if it has to and that the sanctions do not prevent it doing so.

In passing, a successful bond issue will also show that the market does not agree with the repeated downgrades of Russia’s credit rating carried out by the three big international credit rating agencies - a fact which the Russians, who are in constant dialogue with the credit rating agencies, will doubtless point out to them.

As to the likely success of the issue, the growing consensus is that - as I predicted - barring a sudden catastrophic change in the international situation or in the world economy, it will find no lack of buyers and will therefore be a success, though - as The Economist also correctly points out - the Russian government can also borrow on its own domestic financial markets within Russia itself - as it has previously done - if it has to.

Many of the likely buyers of the Eurobond will in fact be Russians or Russian companies, which are currently awash with dollars.

I would add that I remain of the view that fears that the Reserve Fund will be completely exhausted by 2017 or that Russia will have to borrow more in that year are being overdone.

Regardless, the flesh-creeping talk of Russia being about to run out of money and of being unable to fund its budget is simply wrong.  

Like so much else written and said about the country and its economy it is a claim which derives more from myth than reality.

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First published by the The Economist

Russia last issued a dollar-denominated bond in 2013. Since then it has annexed part of Ukraine, launched a proxy war in another bit and destabilised the rest. That prompted Western financial sanctions on Russia’s banks and oil firms. Its government, though, can still tap foreign debt markets. On March 1st the ministry of finance said it would appoint advisers this month to help it issue a $3 billion bond.

One explanation might be a need for foreign cash. As Russia’s recession has eased, the government’s cost of borrowing has fallen. It could be planning to filter the dollars to favoured companies. That would help firms struggling to service foreign debt thanks to sanctions and the halving of the value of the rouble since 2014. Alternatively, the government could use the money for itself. The budget assumes an oil price of $50 a barrel and a corresponding deficit of 3% of GDP in 2016. Now the oil price has crashed to $30, the deficit could reach 7% of GDP.

But the private sector is not as desperate as it was, having reduced its external debt by about a third over the past two years. No big foreign-debt repayments are looming. Many firms still have high levels of foreign assets, according to Liza Ermolenko of Capital Economics, a consultancy.

Nor is the government in dire straits. The reserves of its sovereign-wealth funds, which Russia is already using to fund the budget deficit, still exceed $100 billion. The finance ministry is expected to propose a new budget in April, which will trim the deficit through spending cuts and tax rises. The government can readily borrow roubles, and the interest rate on dollar borrowing is likely to be high.

That suggests that the Russian government sees the bond as a long-term, strategic move. It has tapped domestic markets in the past when running budget surpluses, to prove that it could borrow more if it needed to, says Ms Ermolenko. A successful trial would be reassuring to the Kremlin, since Russia’s sovereign-wealth funds are likely to run dry within a few years if oil prices stay low. “There will be much more to come,” says one banker, who reckons that Russia will seek to borrow $6 billion-8 billion next year.

A successful international bond placement would also be a public-relations coup. Russia must tread carefully, since Western banks are wary of cavorting with the Kremlin—hence the small sum to be raised. Yet all the signs suggest that Russia will find willing partners.

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