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Pankin: Hike in Domestic Debt Is Planned

Pankin speaking with a reporter. Alexander Zemlianichenko Jr

The government will step up sales of domestic debt and may offer its first ruble-denominated eurobonds after falling behind on its plan for raising 1.2 trillion rubles ($38.9 billion) this year, Deputy Finance Minister Dmitry Pankin said in an interview.

Central Bank data show that the government sold 212.5 billion rubles, or 18 percent of its target, in the first half and may turn to international buyers, Pankin said. Russia issued in April its first bonds to money managers outside the country since defaulting in 1998 and doesn’t plan a second foreign-currency sale, he said.

“We plan to increase our borrowing on the domestic market,” Pankin said. “We are analyzing market conditions and legal questions” for a ruble bond sale overseas, he said.

The government is behind its target after yields rose on concern that the sovereign debt crisis in Greece, Portugal and Spain would spread to emerging markets. Russia’s 11.2 percent ruble bonds due December 2014 yielded 6.76 percent on July 9. They rose as high as 7.67 percent on May 6 from 6.46 percent on April 13, the lowest level since their September sale.

“The volatility is high, and it’s hard to make any long-term plans,” Pankin said. “The situation was very favorable in March and April and everyone thought it would remain stable in May and June, but then the events in Greece happened, and in effect the second half of May saw the market collapse.”

Russia stepped up borrowing as the worst economic slump since the collapse of the Soviet Union led the government to post its first budget deficit in a decade last year, at 5.9 percent of gross domestic product. The government expects the budget gap will be 5.4 percent this year. Russia will be unable to raise the funds it needs from the domestic market alone, according to ING Group, Bank of Moscow and Renaissance Capital.

“They won’t be able to place the full amount this year,” said Leonid Ignatyev, a fixed-income analyst at Bank of Moscow, which is controlled by the capital city’s government. “The Finance Ministry will have to offer an even bigger premium to the market, especially as the outlook for the domestic debt market may significantly worsen in the fall.”

The government may sell as much as 500 billion rubles of local bonds, including 100 billion rubles to refinance existing notes, according to Bank of Moscow. Investors may be willing to buy a maximum of 600 billion rubles, said Konstantin Kostrub, head of fixed-income trading at ING Group in Moscow.

“To borrow 1 trillion rubles, they have to borrow 40 billion rubles to 50 billion rubles every week until the end of the year, and this is too much,” said Nikolai Podguzov, a fixed-income analyst at Renaissance Capital.

Russia may have to offer investors a premium of as much as 1.5 percentage points over nondeliverable forwards to sell the remaining portion, ING’s Kostrub said. Three-year NDFs are at 5.16 percent, compared with the 6.16 percent yield on federal notes, called OFZ, due January 2013.

NDFs provide a guide to expectations of currency movements as they allow foreign investors and companies to fix the exchange rate at a specific level in the future. NDFs show the ruble at 31.07 per dollar in three months. The ruble weakened 0.2 percent to 30.90 per dollar on July 9.

Russia’s dollar bonds due in 2020 sold in April were little changed, yielding 5.329 percent, the lowest level since June 21. Credit-default swaps linked to Russian debt fell 9 basis points, or 0.09 percentage point, to 181 on July 8, the lowest level since June 22. The contracts, which investors use to hedge against losses or speculate on creditworthiness, pay the buyer face value if a borrower reneges on its obligations.

The difference in yield between Russia’s ruble bonds due 2036 and dollar securities due 2030 has narrowed to 215 basis points from 265 on May 10, data compiled by Bloomberg show.

Investors reduced the extra yield they demand to hold Russian debt rather than U.S. Treasuries by 4 basis points to 260 on July 9, according to JPMorgan Chase EMBI+ Indexes. The gap compares with 169 for debt of similarly rated Mexico and 228 for Brazil, which is rated two steps lower, at Baa3, by Moody’s Investors Service.

“We think the internal market can absorb our borrowings, while the external one may be more volatile,” Pankin said. “The question of offering a premium will depend on market conditions, on demand for the securities and what the situation will be with budget revenues.”

Pankin ruled out tapping the government’s Reserve Fund to lower the debt issuance target. The Finance Ministry plans to borrow a further 1.5 trillion rubles from domestic markets next year and 1.3 trillion rubles in 2012, according to budget proposals.

Russia is “reorienting from the external to the domestic market," Pankin said. “The domestic ruble market is what we care most about and our goal is to make it more effective so we can issue debt there.”

The government’s plan to stick to ruble bond sales underscores President Dmitry Medvedev’s drive to boost the currency’s role in world financial markets, said Alexandra Yevtifyeva, an economist at VTB Capital.

“It’s quite in line with the government’s attempts to develop Moscow as a financial center and turn the ruble into a reserve currency,” Yevtifyeva said.

The government may still choose to sell less debt than planned after lowering its budget deficit goal for this year by 1.4 percentage points, according to Mikhail Galkin, head of fixed-income research at VTB.

“The Finance Ministry won’t raise the money at any cost, especially since the latest budget execution data is strong,” Galkin said.

Russia should have conducted bigger auctions at the beginning of the year to avoid the risk of missing its issuance target, said Stanislav Ponomarenko, an analyst at ING Group.

“This is something the markets won’t be able to ignore — roughly 100 billion rubles of new debt per month,” Ponomarenko said. “There will be a lot of pressure on the secondary market.”

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