Russian Fixed Income Daily
- Economics: fiscal performance solid
- Tough environment for today\'s OFZ auction
- Opportunities outlined in short bonds...

FX and money market

On Tuesday, the rouble was under pressure of the dollar’s growth against the euro in international markets. As a result, the rouble depreciated to 27.09/USD losing eight kopecks. The rouble continues to chase the volatile euro/dollar exchange rate. Today, market players will focus on US macroeconomic releases, particularly on CPI, which is expected to help clarify how much higher the Fed will lift the refinancing rate at the meeting this month and beyond. We see the rouble today in the range of RBL/USD27.07–27.12.
In the money market, rouble liquidity looks stable with interbank overnight interest rate at 1.5-2%. We do not expect any strong turbulence in the next few days.

Olga Golub, Moscow (7 495) 755 5176


Rouble bond market

Tuesday was definitely a very weak day on the domestic bond market: the sharp fall of Russian stocks induced marked selling activity in rouble bonds, but as usual, no-one was bidding, so the market primarily responded to the weak sentiment with low trading liquidity and wide bid-ask spreads. Overall, the price movement was not dramatic (20–25bp downwards), although the trend was absolutely clear.
The spread of Russia’30 over US10Y is currently 135(+4)bp (very wide, with a compression potential of 40bp from an historical standpoint), while the spread of OFZ 46018 over Russia’30 is 50(+0)bp (wide in a medium-term perspective, our target for the spread is 0bp).

Complex environment for today’s OFZ auction
As the market situation is currently very shaky, it will be very interesting to see how today’s OFZ auction goes.
The paper being offered is a definite market benchmark: OFZ 46018, size RBL9bn, maturity in 2021, duration 8.2 years, current coupon 9.5%.
The latest large auction for the bond was held on 15 March, when RBL6.9bn of OFZ 46018 was sold to the public with an average yield of 6.9% and cut-off yield of 6.92%.
Yesterday, as mentioned, the spreads were quite wide, so the best bid for OFZ 46018 was located at 6.84%, while the mid-market yield was 6.82%.
In our opinion, during today’s auction MinFin is unlikely to be led by the market and will prefer to place less of the paper rather than give the participants substantial premium. On the other hand, the situation is currently quite risky, so considering the long duration of the bond, we would still recommend to demand at least something, and hence, place orders for OFZ 46018 at 6.86% and higher.

Secondary trading
Price changes of high-grade rouble bonds: OFZ 46018 -25bp, Moscow-39 -28bp, Moscow-44 -39bp, FSK UES-2 -35bp, Gazprom-4 -27bp, Lukoil -21bp, RZhD-6 -17bp.
Second-tier papers: MosReg-6 -17bp, CenTel-4 -22bp, ChTPZ -45bp, GBP -25bp, Integra -15bp, Magnit +10bp, SibTel-4 -15bp.
Definitely, in the current market conditions, the attention of participants will be focused on relatively short papers, so below is a list of our picks in this segment.
TMK-3 – a bond of the Tube Metallurgical Company (TMK) – has been recently stable in the range of 8.1–8.2% YTP for 21 months. Above 8% the paper definitely retains speculative upside as we believe that its fair value in current market conditions is in the range of 7.75–8%. Short-term investors should also not forget that TMK-1 currently also offers a good buying opportunity, being traded at 8% for five months.
Impex-3, a bond of Impexbank recently acquired by Raiffeisen, was quoted at about 8.1% to put in 12 months. Due to the acquisition, the bank has been upgraded by Fitch and Moody’s to investment grade rating BBB-/Baa2, and by S&P to BB+, so now it continues to be above its fair yield, which is located somewhere in the range of 7–7.5%. We definitely recommend accumulating Impex-3 for passively managed portfolios.
Baltika is still trading at 7.8% to maturity in 17.5 months, which is very high, taking into account the high credit quality of this issuer. The fair value of this paper is probably below 7.5%, but low liquidity does not allow it to occupy this position. As a result, if Baltika can be found above 7.5% YTM, it’s a buying opportunity. Actually, the current selling sentiments on the market could help find a good offer for this paper.
RusAl-3, which we’ve been recommending as a good purchase, yesterday traded at 7.83% to maturity in 28 months – a paper probably a bit longer than can be expected to be attractive now, but considering a good yield, still a good purchase. We have many times stated that we estimate the fair YTM of RusAl-3 at 7.5%.
And finally, the bonds of Russian Standard bank are still attractive. RSB-4 was yesterday trading at 8.64% to maturity – perhaps, about 35bp higher than it should be. Russian Standard bank is rated B+/Ba2 by S&P/Moody’s.

Market view
All market participants need to understand that the current selling is occurring simply due to the very negative sentiment on the stock market. It is hard for us to say, when the downward correction will end, but what is certain is that the net demand for rouble bonds, especially high-quality ones (OFZs), will continue to support the domestic bond market this year.
In addition, rouble liquidity is now very high and is not expected to significantly diminish in the second half of June. Last week the market went through a local peak in primary supply without notable problems, so interest for local debt is still there but the pipeline of new placements notably emptied.
Taking this all together, we are keeping our Hold recommendation for long rouble bonds in expectation of three main positive factors: (1) improvement of international sentiment toward emerging markets, as we really do not see any more reason to widen the spread of Russia’30 over US Treasuries, (2) continuation of rouble appreciation in the medium-term perspective, and (3) capital account liberalisation, which should take place on 1 July.

Dmitry Dudkin, Moscow (7 495) 755 5480


Fiscal performance solid
In January–May, the budget surplus rebounded to 4% of GDP (9.5% of GDP on a cash basis)
Yesterday, the MoF reported on the fiscal performance for January–May 2006, which as expected was good, with budget revenues spiking to RBL2397bn (US$88.5bn). The budget surplus rebounded from a very modest -0.03% of GDP in January–April to RBL374bn, or 4% of GDP, which had been expected. What raises some concerns is that the gap between budget expenditures on an accounting basis and budget expenditures on a cash basis remains high at RBL514.8bn, although this is lower than in April’s gap of RBL657.9bn (US$24bn). This happened because the MoF “postponed” RBL514.8bn of expenditures that were made in the accounting books but not spent in cash. Although this is quite a common method for additional sterilisation, the MoF must make all of these expenditures in cash in 2006 and thus also add to the increase in inflation later.
We remain very optimistic about the fiscal figures for 2006 as a whole and maintain our view for a fiscal surplus at 5% of GDP (RBL1300bn). In May, the MoF upgraded its view on 2006 from the RBL776bn set in the 2006 budget law to RBL1336bn. According to the ministry, additional budget revenues could reach RBL550bn, which seems to be a realistic estimate. The Duma wants to consider the issue of additional budget revenues and their spending before its summer holiday, thus scheduling more expenditures for 2H06, which will increase inflationary pressure. Although further fiscal softening looks unavoidable, strong appreciation of the rouble should significantly reduce actual inflationary consequences.
Fiscal eldorado:

Jan–May – actual results 2006 budget law ING view on 2006
Revenues, RBLbn 2397 5046.1 6000
Expenditures (accounting basis), RBLbn 2023 4270.1 4700
Budget surplus (accounting basis), RBLbn 374 776 1300
Budget surplus (accounting basis), % GDP 4% 3.2% 5,0
Budget surplus (cash basis), RBLbn 888.8 - -
Budget surplus (cash basis), % GDP 9.5% - -
Source: MinFin, ING
Investment implications: Fiscal performance in January–May was sufficiently strong with a budget surplus of 4% of GDP. Negative consequences of further fiscal softening are avoidable, as monetary and fiscal authorities allowed the rouble to appreciate. We maintain our forecast of a budget surplus at 5% of GDP in 2006.

Julia Tsepliaeva Moscow (7 495) 755 5489