Russia has just enjoyed one of those rare summers where the weather was perfect and the markets kind, especially for investors in emerging market Eurobonds.
This autumn’s capital market reforms could spark a rally, the first signs of which are already apparent. Moscow’s major exchanges were merged last year and a Central Securities Depository (CSD) has been created.
Next up, Russian local bonds will become accepted for settlement through the Euroclear and Clearstream international settlement systems – probably in November – opening up the market to entirely new pools of capital.
Currently, the ruble bond market is dominated by Russian banks, which hold a combined portfolio of around $150bn, or about 60% of domestic corporate bonds and state OFZs. Domestic institutions account for another 20% of investments in the local corporate market.
And demand is increasing, as the assets of the Russian banking sector are growing by 20% a year on average. In times of crisis or difficult markets, Russian banks prefer to repo bonds with the Central Bank of Russia (CBR) rather than sell, which keeps the volatility of bonds low – only 3.5% compared with the annualised return of over 10% in the last five years (measured by the Russian local corporate bonds Cbonds index).
More generally, persistent high inflation in the last two decades was another disincentive for bond investors. But since the CBR switched its efforts from maintaining exchange rate stability to inflation targeting, this problem, too, has fallen away.
Inflation this year will probably come in at 6-7%, but it is expected to stabilise at around 4.5-5.5% in the medium term.
Finally, the ruble’s dynamics is supporting the credit case. The ruble is cheap at current levels on most metrics, including the longer-term ruble real effective exchange rate, and despite high oil prices scepticism has prevented the ruble from outperforming the emerging market average.
The ruble, however, has a much higher carry than the global emerging market average. It is also one of the cheapest commodity currencies.
Despite the robust fundamentals, foreign investors are still ignoring the ruble bond market and account for only 5.8% invested in OFZs, against the average amongst Russia’s emerging market peer group of 20%.
That will change this autumn when Russia should emerge as one of the hot spots in the world and as Russia’s ruble bond market comes of age.