BofA Sees Deficit Risk on Oil as Auctions Vanish: Russia Credit

By Vladimir Kuznetsov

Oil falling below $100 a barrel for the first time in 15 months is a signal that Russia can’t stay out of the bond market indefinitely after the Finance Ministry canceled its eighth auction in a row.
Crude dropped to $98.96 in London today, what would be the weakest level on a closing basis since April 17 last year and a 12 percent retreat in the third quarter. Ruble-denominated debt handed investors the biggest loss in the period in dollar terms among 31 emerging markets monitored by Bloomberg.
With no auctions since mid-July, a steeper decline in Russia’s main export earner could flip the nation’s $19 billion budget surplus into a deficit by year-end, according to Bank of America Corp. U.S. and European Union sanctions over Ukraine drove
10-year ruble borrowing costs 120 basis points higher since June. That compares with a 66 basis-point drop in Brazilian yields.
Oil at current levels means “the budget surplus will be erased by the end of the year,” Vladimir Osakovskiy, an economist at Bank of America in Moscow, said by e-mail yesterday. A $10 drop in the average price “will make borrowing needs more apparent,” he said.
Should the price fall by that amount, the budget will end the year with a 600 billion-ruble to 700 billion-ruble ($16 billion to $19 billion) shortfall, according to Osakovskiy.

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Borrowing costs of the world’s largest energy exporter have come under pressure this year as the standoff over Ukraine escalated, with the U.S. and EU imposing penalties to punish President Vladimir Putin for his alleged role in separatist unrest in Ukraine’s east.
Bonds extended declines after the Bank of Russia raised its main interest rate by 50 basis points to 8 percent on July 25, taking its total increase since Putin’s March incursion into Crimea to 250 basis points. The rise in Brent to as high as $115 a barrel in June and the weaker ruble have so far helped the country shelve bond sales since the depreciation boosted its dollar-denominated oil proceeds.
Government bonds due in February 2027 yielded 154 basis points above the central bank’s key interest rate. That’s 30 basis points higher than the last time Russia said it would proceed with a local bond auction on July 15, before the U.S. and EU imposed penalties blocking Russian companies from accessing funds abroad.

‘Too Expensive’

“The yield is too expensive and the Finance Ministry doesn’t need to borrow at such a cost,” Konstantin Nemnov, the head of fixed income at TKB BNP Paribas Investment Partners in St. Petersburg, said by phone yesterday. “Sanctions are making investors nervous, hence the premium.”
Russia’s five-year bond yield climbed above the rate on 10-year notes for the first time in two years on July 28. The spread was zero yesterday, after widening to as much as 12 basis points on Aug. 11.
“Investors don’t want long bonds now, it’s too large a market risk,” Dmitry Dudkin, the head of fixed-income research at UralSib Capital in Moscow, said yesterday. “There’s no premium to shorter debt and the Finance Ministry doesn’t want to sell short bonds.”
The borrowing-cost pressure may keep climbing as analysts at banks including Sberbank CIB project the central bank will lift interest rates again as early as this week. Eight of 22 analysts in a Bloomberg survey project policy makers will increase the main rate by as much as 50 basis points at their Sept. 12 meeting. The rest expect no change.

Any Price

While the government has leeway to refrain from debt offerings due to the weaker ruble, it will be harder to carry on with the same strategy next year, Konstantin Artemov, a money manager at Raiffeisen Capital Asset Management, said yesterday.
The currency weakened 0.3 percent at 37.2325 per dollar at 11:28 a.m. in Moscow, bringing this year’s retreat to 12 percent, the third-worst among 24 developing nations monitored by Bloomberg. Russian local-currency notes in the Bloomberg Emerging Market Local Sovereign Index lost 11 percent this quarter.
“The Finance Ministry fully realizes that it’s not so much the problem of this year as the problem of next,” Artemov said. That’s when it will need “to enter the market and borrow at any price,” he said.