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As the only real source of capital for growing companies, Russia's domestic bond market is booming after Russian companies and banks raised RUB960bn in 2011 and are expected to raise another RUB1.5 trillion this year, or 3% of GDP, reports Profile.

"Issuing bonds seems to be the only possible way of borrowing for many large issuers whose borrowing programmes are estimated at tens of billions of rubles," says Leonid Despotuli, director of investment services and underwriting at Svyaz-Bank.

Russia's banks just had their most profitable year ever in 2011, but they are sitting on their cash and unwilling to lend or take on new customers. "The situation is particularly bad in the regions," says Simon Dunlop, who owns the regional cinema chain Kinoplex. "Companies are paying about 18-19% on their debt and normally at this point you would go to the bank to renegotiate and extend the terms while business picks up. But the banks are insisting on companies paying back the principle when it comes due. This is a huge drain on cash flow and it backs up to suppliers who are asked for pre-payments and so cancel their discounts. It means everyone is working for the bank and can't do anything else about developing the business."

The unwillingness to lend, especially to small and medium-sized enterprises in the regions means the recovery of Russia's economy has stalled. High oil prices have put the federal budget back in the black with Russia reporting a $20bn surplus in February, according to the Ministry of Finance, and business in Moscow has clearly turned the corner, but almost all of Russia's regions are still wallowing in a creditless torpor. "Look at lending to SMEs in Russian regions. The sharp drop in 2008 should not surprise anyone, but what is shocking is the performance in 2010-11. There has been absolutely no recovery and it continues to slide downwards," says Gennady Minovsky, an investor with several assets in Russia's regions.

Part of the reason for the reluctance of Russian banks to lend is that liquidity in the financial industry remains extremely tight. The Central Bank of Russia (CBR) has been forced to inject extra cash into the bank system in March after a huge outflow caused by the VAT for the fourth quarter of 2011. Capital flight of about $85bn in 2011 has also left banks short of cash - although on this score the CBR expects the flow of money to reverse in the coming months. As a result, the interbank interest rates (the main source of funds for most of Russia's smaller banks) have risen to 5.0-5.6% in March, up from 4.4-4.8% in February, which further discourages lending. "The banking sector's net liquidity position remains negative (the volume of short-term obligations exceeds the volume of liquid assets by RUB150bn or $50bn), which will not allow interest rates to decline substantially from the current levels," Aton Capital said in a note on March 23.

The dearth of credit has pushed companies to raise money on the bond market and local bonds make up some three-quarters of Russia's banking sector's exposure to securities. The biggest blue-chip companies have been especially active and enjoy the best terms. In particular, there are 14 outstanding issues of bonds of Russian Railways worth RUB195bn and 10 issues of bonds of FGC UES worth RUB105bn on the market. Other companies, too, announced their plans for large-scale borrowings using bond issues. "The bond market is an important source of raising capital for medium-sized companies too," Leonid Despotuli told Profile. "Many such companies placed bond issues successfully last year although they had never done it before,"

Half of all the issues in 2011 were debut bonds from companies with no previous bond rating, meaning the share of smaller-cap companies made up more than 15% of the total bond market capitalisation at of the end of 2011.

And the local bond market should grow this year. In June, Russia's Central Securities Depository (CSD) will go online, which will throw the local debt market open to foreign investors. Given Russia's relatively stable macroeconomic situation and strong fundamentals, coupled with the relatively high interest rates companies are willing to pay for money, all the ducks are lining up for a bumper year on Russia's debt markets.