Ben Aris in Moscow -
Russia's Economy Ministry has announced it will offer RUB1.5 trillion ($46bn) worth of bonds to finance the planned splurge in infrastructure projects. Given the recent appetite that global investors have shown for Russian assets, pundits expect to see good demand for these new bonds.
Russia has massively ramped up investments into its crumbling infrastructure in recent years as part of a grand plan to invest at least RUB 1 trillion into modernising the country. A slew new spending has been announced in recent weeks that will add to the approximately $100bn a year the Kremlin has already been pumping into infrastructure since the start of 2008 (and will continue to spend until 2015) despite the global crisis. For comparison, the Kremlin spent just $7bn on infrastructure in 1999, according to Goldman Sachs.
Russia will have to find RUB9.6 trillion over just the next three years for 48 major infrastructure projects of which RUB2.2 trillion will be borrowed, Deputy Minister Sergei Belyakov was quoted by Vedomosti as saying. Among the projects requiring finance are the development of the massive Yamal gasfield and associated liquefied natural gas (LNG) plant, a central ring road around Moscow region, and Moscow's airports.
"Infrastructure bonds could be transformational for Russia at multiple levels," argues Plamen Monovski, chief investment officer of Renaissance Asset Managers, which includes Russia's biggest infrastructure fund amongst its products. "At the most basic level Russia needs to fix its infrastructure, which will greatly enhance the growth of the economy and the productivity of the country. This is one of the most desirable kinds of investment the government can do."
Monovski says he is also encouraged that the bonds suggest the government sees the need to get foreign investors involved and that while several other emerging markets are chasing international investment into infrastructure, an infrastructure bond comes with the backing of the state. "We are talking about long-term, high-yielding, guaranteed bonds that are backed by the state - who wouldn't want those in your portfolio?" says Monovski.
The bond announcement seems to be part of a wider policy of upping Russia's game when it comes to both infrastructure and the capital markets.
The state has been spending about $30bn a year on upgrading the country's railway system, and more recently moved onto roads with a new road fund. Then at the start of September, Rosmorport, a state-owned company for development of maritime transport, released a new version of development plans through 2030 that sees cargo traffic rising from 540m tonnes in 2011 to nearly 900m tonnes by 2020.
Likewise, the state poured $20bn into giving the far eastern capital of Vladivostok in a face lift ahead of this month's Asia-Pacific Economic Cooperation summit, but has already invested three-times that amount into the infrastructure of the surrounding Primorye region as part of a plan to attract more foreign investment there.
The same story is happening at a regional and city level too. Moscow announced in mid-September it will invest $5bn a year on improving the metro and all 13 of the cities due to host the 2018 World Cup in Russia.
The bonds also fit in snugly with the state's efforts to develop its capital market. Russia will be hooked up to the Euroclear international settlement system, expected to happen in November, and its newly minted Central Securities Depository should become fully functional at the same time, opening up the Russian bond market to new pools of capital such as international institutional investors, who no longer need to open accounts with local brokers as a result. International investors have been able to buy Russian bonds over-the-counter since February and funds based in London report they have increased their Russian allocations as a result.
Analysts at VTB Capital say the share of foreign investors in the Russian bond market could double or treble in just the first few months, owning up to 15% of outstanding sovereign ruble bonds after the reforms as traders rebalance their portfolio to reflect Russia's increased weighting in the international indices.
An infrastructure bond would also provide a good instrument to build up the domestic institutional investors that Russia's market is currency missing - a major source of the volatility that plagues Russia's capital market.
Russian ruble bonds are very attractive in their own right. The Central Bank of Russia changed its priority from exchange rate stability to inflation targeting a few years ago and surprised economists last week by hiking rates to 8.25% after inflation crept above its 6% target to 6.4% on an annualised basis due to rising food prices. Economists in Moscow said the decision had more to do with cementing the CBR's reputation as an inflation-fighter than any economic necessity.
However, with Russia sporting two-decade lows for inflation, real ruble bonds yields have turned positive for the first time since 1991 (see chart) and are becoming increasingly attractive. Renaissance Asset Manager's head of fixed income, Elena Kolchina, is recommending investors switch out of Russia's Eurobonds to ruble bonds on the back of falling inflation and returns on equity of over 20% amongst Russia's best infrastructure companies such as Globaltrans, Brunswick Rail and Etalon.
Russia's leading companies have been taking advantage of the growing enthusiasm for ruble-denominated fixed-income with a growing volume of issues. At the same time, Russia's improved macroeconomic position has seen yields on sovereign bonds fall from double digits to around 6% now. The reforms to the capital market due in November could drive yields down further. And with inflation also expected to fall back to between 4.5% and 5.5% next year, the outlook for Russian ruble bonds is good - always assuming global financial conditions don't suffer another turn for the worse.
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