US preparing 'black swan' for Russian sovereign debt

US preparing 'black swan' for Russian sovereign debt

Extended US sanctions on Russia that cause foreign investors to pull out of its bond markets is a potential 'black swan' for 2018 that could trigger big ruble falls, Bank of America Merrill Lynch (BAML) said in a note.

BAML stressed a scenario extending U.S. sanctions on sovereign debt was unlikely and also predicted that should it materialize, Russian authorities would be able to deal with the fallout.

"Pressure could be material and will likely depend on the scale of the imposed sanctions. More specifically, an attempt to fully cut off Russia from external capital markets could trigger renewed demand for (hard currency), similar to the spike in such demand in late 2014," the note says.

But the US is now considering restrictions also on buying ruble-denominated government bonds (OFZs).

BAML predicted that such a development would send Russian yields 100-150 basis points higher, noting foreigners currently hold almost $37.2 billion worth of OFZs (a third of the market). Another $14.5 billion of external sovereign debt is held by non-resident investors.

The bank added that external debt issued by Russian companies and banks - currently worth some $450 billion, also is likely to come under pressure if the sovereign comes under sanction.

The analysts said the effect would be felt most on the ruble, in a possible repeat of 2014 when the central bank first spent billions defending the currency, raised interest rates sharply and eventually allowed it to float.

"On the back of repatriation of $37 billion from non-resident OFZ holdings, the ruble might also suffer from likely renewed dollarization among the population," BAML warned, but did not say how much the rouble could fall.

The analysts were confident however that Russia’s central bank, praised for its handling of the crisis and for prudent monetary policy, can cope with the sanctions fallout. They expect it to react along the lines of 2014 when it extended a $50 billion repo facility to banks, allowing them to pick up the dollar bonds foreigners were selling, Reuters reported.

On OFZ markets, BAML noted local banks had some 2 trillion rubles in deposits with the central bank, money that could be re-allocated to OFZs.

American essayist and risk analyst, Nassim Nicholas Taleb's black swan is an event or occurrence that deviates beyond what is normally expected of a situation and is extremely difficult to predict. 

Chairman of the State Duma’s Financial Market Committee, Anatoly Aksakov, speaking with Vestnik Kavkaza, expressed confidence that the US sanctions against Russia's sovereign debt will not do much harm to the Russian financial system due to the fact that Moscow does not intend to increase it. "Our state debt is rather small, it is approximately 13.5% of GDP. The Finance Ministry is trying to increase it to finance the budget deficit, which, according to the government's forecast, will be 1.3 trillion rubles. But the budget is calculated based on the oil price of $40 per barrel, and the real oil price now exceeds $60 per barrel, which means significant additional revenues. So there is no point in attracting borrowings in foreign markets," he explained.

Moreover, according to Anatoly Aksakov, Russia will be able to repay its foreign debt through additional revenues from the sale of oil. "It would be better to direct the reserves to repay the state debt, after all, it is planned to spend more than 800 billion rubles on its maintenance. Therefore, I do not see any risks for our budget system in the US ban on the acquisition of Russian sovereign securities. In addition, it is clear that Russian bonds are guaranteed and sufficiently profitable securities, and they will be of interest to other investors," the chairman of the State Duma’s Financial Market Committee believes.

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