Russian Fixed Income Daily
- Buy recommendations maintained from RusAl-2, Salavat-2 and Gazprom-3
- Baltika downgraded from Buy to Hold
- Bashkirenergo and TMK added to Buy list..

FX and money market

Last week, following the euro’s trend the rouble remained volatile with intraday fluctuations +/- 5-10 kopecks and on Friday it traded around RBL/US$28.30-28.35. In the middle of the week the CBR allowed the rouble to appreciate above the bi-currency basket and the rouble gained some 10 kopecks against the dollar, however, then it was linked to the bi-currency basket again. In the short-run, without a clear FX policy from the CBR the market is likely to be sluggish. Today, as a result of the disappointing results of German elections the euro dropped to US$/EUR1.2103 which created downward pressure on the rouble. Scheduled for Tuesday the FOMC meeting is the main event for this week which could influence the dollar performance, however market expectations regarding a further increase in the US refinancing rate are partially priced-in. In the coming week we expect the local currency to remain depending on the euro/dollar trend, and today we see it in the range of RBL/US$28.44-28.49. In the money market we do not rule out a shortage of rouble liquidity this week due to VAT payments scheduled on 20 September.

Olga Golub, Moscow (7 095) 755 5176

Rouble bond market

On Friday government securities continued correcting downwards after a large rally, although this correction was slower than on Thursday. Municipal and corporate sectors on average remained unchanged, showing now clear tendency.

Meanwhile, US Treasuries continued their decline, with US10Y reaching yield level 4.28% compared to 4.2% on Friday morning. In line with our view, US10Y is heading for its first technical yield resistance located at 4.35%, which

is then followed by a large downward sloping trendline, now at 4.52%. Because of the gradual falling of US Treasuries, Russia’30 is now trading lower than recently – close to 114.375, keeping its sovereign spread at historical lows.

The money market remains in a very good shape: 1-day MIBOR currently equals 1.66%, which is quite low; the balance in correspondent accounts exceeds RBL300bn – again, quite a solid figure. Nevertheless, tomorrow Russian companies will be paying the VAT, followed by the mineral resource tax on September 26 and the profit tax on September 28.

Corporate sector

Price changes of corporate benchmarks in secondary trading: Gazprom-4 -10bp, Lukoil -5bp, RZhD-3 +8bp, FSK UES +11bp. Second-tier bonds: Baltika +20bp, Salavat-2 +14bp, CenTel-4 -26bp.

Salavat-2 (now yielding 8.45% to maturity in 4 years) is currently paying a premium of 40bp over NKNH-4, which is ungrounded from a credit standpoint. An additional good feature of Salavat-2 is that it has a 1.5-year put option protecting the bond’s downside. The yield to put of Salavat-2 is still 7.11%, so in case of a significant adverse movement in interest rates this yield will be secured. We maintain a Buy recommendation regarding Salavat-2 with a YTM target 8.25%.

As indicated above, Baltika gained 20bp on Friday, thus reaching YTM level 7.62%. As our target for the bond is currently located at 7.5%, we believe it is time to change our recommendation for Baltika from Buy to Hold.

Similar to Baltika, RusAl-2 finally shifted on Friday upwards and is now yielding 7.42% to maturity in 20 months. On the other hand, our target set for the bond is still quite a long way off – at 7.25%, so we maintain a But recommendation for RusAl-2.

We also believe that additional interest to RusAl-2 will be drawn due to the placement of RusAl-3 the company is planning for Wednesday. The issue will have a size of RBL6bn, semiannual coupons and 3 years to bullet maturity. We will publish price guidance for the auction after the issue presentation scheduled for today.

Also, Gazprom-3 resumed upward movement on Friday, having added 19bp to its price and descending in YTM to 6.11%. We estimate the fair level for the bond to be located at 5.75%, so we maintain a Buy recommendation for the paper while it remains above 6%.

Today we also issue 2 new Buy recommendations: as we believe that now it is the best time to buy shorter issues, we recommend TMK (7.86% for 13 months) and Bashkirenergo-2 (8.1% for 17.5 months). We believe these bonds are currently offering a very good yield/credit risk tradeoff and are not lacking a possible price upside.

Short term market view

We believe that falling Treasuries, tomorrow’s FOMC decision and approaching tax payments pose a notable threat to prices of long rouble bonds, especially at the moment they are located at historical tops after a large rally. This supports our idea that this week is ideal for profit taking in the longest issues and paying more attention to protective shorter securities. This does not preclude buying several long bonds mentioned above that currently have a significant upside relative to the market.

Dmitry Dudkin, Moscow (7 095) 755 5480

Industrial production growth – below expectations

In August, industrial output went up by 3.4% (YoY), resulting in a slowdown to 3.7% (YoY) in January-August

Last Friday, the FSSS released its industrial production figures for August and January-August, which were below expectations. Industrial output expanded by 3.4% (YoY) in August, resulting in a drop of the cumulative figure from 4.1% in January-July to 3.7% (YoY) in January-August. Raw material production growth was very low – just 0.2% (YoY) in August and 1.2% in January-August – and was the principal factor for the general slowdown. This was not very a good result, even though the reasons for this slowdown are clear – mainly the oil sector- and can be attributed to the drop in Yukos’ production, the worsened climate for the oil sector in general, and increased tax pressure on the oil sector.

Unfortunately, growth in manufacturing goods production also soured from 7.2% (YoY) in July to 4.9% in August. Although investment and consumer demand remain high (growth in construction materials exceeded 10%), machinery slowed down. Nevertheless, we expect high disposable income growth and investment expansion will continue to stimulate manufacturing production, accelerating its growth in the coming month. Production and distribution of electricity, gas and water also continued to rise 3.5% (YoY), or 2.1% in January-August – much above the modest result of 2004 (0.1%).

We maintain our forecast for industrial production growth at 5.5% in 2005, even though poor results in August did not confirm our optimism. Political risks are gradually declining – which should result in further acceleration of growth as well as continued expansion of domestic demand. The base effect will also be supportive for growth figures in September-December 2005.

Investment implications: Although August’s production figures were low (3.7% in January-August), we maintain our forecast at 5.5% for 2005 as a whole. Usually in Russia, statistical data releases do not significantly impact markets, but poor growth figures might encourage the Kremlin to consider a new industrial policy.

Julia Tsepliaeva, Moscow (7 095) 755 5489