Russian Fixed Income daily

FX and money market

Last Friday, the rouble weakened by 2.8 kopecks reaching 26.8719/USD (tom) as the dollar rose in global markets on news from Asia. Nevertheless, this strengthening was not sustained and today the euro appreciated above USD1.275/EUR again, pushing the rouble to the 26.8-26.82/USD zone.

This week we do not expect a clear trend in the euro/dollar exchange rate. The market will remain volatile, consequently inducing up to 10-15 kopecks volatility of the rouble against the dollar. At the same time, market sentiment for the rouble remains positive. Big players in the Russian FX market are still short on dollars (we estimate their positions at some US$5bn this week while they were at US$8-10bn last week) and expect the CBR to allow the rouble to jump against the bi-currency basket. We also believe that this will remain the likely scenario for the coming couple of weeks, although the CBR usually prefers to keep the situation non-transparent and the timing of its new hikes as unpredictable as possible, which reduces the probability of the bank’s immediate reaction. We see the rouble in the range 26.65-26.90/USD this week.
In the money market, overnight rates rose to 4.5-5% while the weekly rate stays around 3-4% – a typical picture for the end of the month with all players believing that this modest liquidity squeeze is very temporary. This week we expect liquidity to improve and interbank rates to drop below 2%.

Rouble bond market

Friday was another strong day in the local bond market, with growth seen both in corporate and government sectors. The main corporate volumes were in FSK UES, Gazprom, and RZhD, while in the government sector, volume and price growth was more modest, with the market being supported by positive sentiment from external markets. US Treasuries debt prices rose on Friday after a report showing soft US GDP growth reinforced investors’ expectations that the Fed would pause its interest rate hikes in August. US gross domestic product rose 2.5%, below forecasts of a 3% rise. As a result, benchmark ten-years notes fell below 5% (which was last seen in June 2006) and consequently, this positive mood spread out to Russian Eurobonds and then to rouble debt. The reaction of the government sector was less visible than the corporate as OFZ’s had no time to react to this news due to an earlier close of trade session. Thus, today we do not rule out that this positive dynamic will continue and that the end-of-month effect will be unlikely to have a strong negative effect on the market.

Company news
On Friday, Russian Standard Bank announced that it will issue one of its two new bonds of RBL5bn at the end of August or the beginning of September. Currently, there are four bonds in the market with totalling RBL16bn. The bond is rating B+/Ba2 by S&P/Moody’s.

Federal Grid Company (FSK UES) is going to place its fourth (time to maturity five years) and fifth bond (time to maturity three years) issues of RBL6bn and RBL5bn respectively. According to the company, the fourth issue should be placed no later than 1 November 2006, while the fifth issue – no later than 25 December 2006. Currently three bonds are trading in the market, totalling RBL19bn. The company is rated by B+/Baa2 by S&P/Moody’s.

Additional OFZ auction
On August 2, the Central Bank will hold an additional auction of OFZ25060 with a volume of RBL9bn. The bond has fixed coupons and matures in April 2009.

Amendments to the Tax code

President Putin has signed amendments that improve tax administration, reduce pressure from the tax authorities, and give some tax pressure relief
Last week, President Putin signed important amendments to the tax code that will help to remove annoying distortions:
•Tax administration will be significantly improved with strict new rules regarding tax checks and investigations. Their mechanism will become transparent, making their use as an instrument of political pressure, as in the Yukos saga, much less likely. We welcome the changes as they will help to reduce political risks. Investors may consider these amendments as a good sign for the improvement of the situation related to property right issues.
•VAT tax will become a quarterly tax from 1 January 2008. This will help to reduce paper work, but will also increase seasonal tax payment peaks (with clearer liquidity squeezes at payment time).
•IT companies will enjoy privileges on the Unified Social Tax (currently, its effective rate is 28% of the total wage fund), which demonstrates the current administration’s course on economic diversification and reduction of the dependence on oil sector. This is good news.
•Mineral resource tax has been diversified. Now, new oil fields will be exempt from the tax as long as their production is less than 25mn tonnes. If oil production is more expensive due to climate/oil quality reasons, oil companies will pay less. The government will introduce a system of coefficients to reflect the stage of exhaustion of a field, with a consequent reduction of the tax. We welcome the reduction of tax pressure for oil companies – which is not bad in the situation of quick rouble appreciation. (World oil price spikes do not significantly help the companies as 90% of their revenues generated on the back of high oil prices when Urals exceeds US$25/bbl goes to the budget). At the same time, the new system of coefficients is likely to make the role of government officials more important as they will decide on how much this or that oil producer will pay, which may increase corruption.

Investment implications: We welcome the improvements to the tax code, in particular in tax administration, as they should result in further reduction in political risks. We also welcome tax pressure relief for oil companies, although cannot rule out that the new system of coefficients will stimulate corruption.