Bondholder’s Dream Beckons as ‘Japanification’ Sweeps Russia

Central Bank of Russia file photo

(Bloomberg – – June 28, 2017 – Anna Andrianova)

From the bondholder’s perspective, Russia has a lot in common with Japan and Italy. That’s a good thing, mostly.

An aging population more prone to saving, combined with a “strongly conservative” economy, offer the best mix for fixed-income investors, according to Renaissance Capital. While poor demographics will haunt Russia’s growth prospects for decades, a hawkish central bank — alongside fiscal restraint by the government — have already turned the country into a magnet for carry traders.

Foreign investors now account for almost a third of the 6 trillion-ruble ($101 billion) market in government ruble securities known as OFZs after buying a record amount last quarter. As Russia broadened access through settlement systems such as Euroclear Bank SA, the share of non-resident holdings jumped from about 6 percent five years ago to more than 30 percent.

“What we might be seeing is a ‘Japanification’ of Russia, where we see a declining population, not very exciting GDP growth rates, lower inflation, high real rates,” said Ivan Tchakarov, an economist at Citigroup Inc. in Moscow. “The other positive fact is Russia’s very strong sovereign position — strong balance sheet, low debt, prudent policy makers.”

Staying on the good side of bond investors is becoming crucial for Russia as it relies more on debt financing to cover the budget deficit after coming close to depleting one of its two sovereign wealth funds following the collapse in oil prices. The Finance Ministry has sold 816 billion rubles of bonds so far in 2017, almost 80 percent of last year’s total. Over 200 investors submitted bids of more than $6.6 billion during Russia’s offering of $3 billion in foreign debt this month.

“We think the bond-friendly team in charge of the central bank and key ministries is doing a good job,” said Charles Robertson, London-based global chief economist at Renaissance Capital. “Today Russia looks like a strongly conservative and aging economy. This is an ideal combination for fixed income investors — see Japan or Italy.”

The Bank of Russia thinks its “moderately tight” stance will keep inflation near its 4 percent target and encourage savings, which it considers a critical resource for investment. Retail deposits have almost doubled in the past five years to 24.3 trillion rubles as of May 1, central bank data show.

Since September, policy makers have delivered only three rate cuts by a cumulative of 1 percentage point. That compares with 4 percentage points of monetary easing in Brazil over the same period. Russia’s 10-year local-currency bonds are yielding 7.63 percent, which is almost a full percentage point below South Africa and 3 percentage points less than Brazil, according to data compiled by Bloomberg.

Russia’s aging population may be giving the central bank a hand in keeping price pressures down because older people tend to suppress inflation by spending less than youngsters. A report by UBS Group AG that analyzed about 50 economies found that countries run up against a disinflationary force as they turn gray.

Poor demographics, however, is mostly bad news for the economy over the longer term. By 2035, the share of people older than the working age may reach 42.6 million, or 29 percent of the total, compared with 24.6 percent last year, the Federal Statistics Service estimates.

As a result of a “plunge” in birth rates in the 1990s, Russia’s working-age population will drop by an average of 600,000 annually over the next six years, according to Economy Minister Maxim Oreshkin.

That’s a major concern for Fitch Ratings, the last major credit assessor that ranks the country above junk. The company puts Russia at BBB-, its lowest investment grade.

“Demographic trends are a reason why growth potential for Russia is considered lower than many other countries rated in the BBB category,” said Paul Gamble, a senior director at Fitch. “Although Fitch considers public finances a strength for Russia’s rating, the aging population will put some pressure on over time, in the absence on pension reforms.”

The government has dawdled over the issue of helping the under-funded pension system by raising the retirement age, currently at 55 years for women and 60 years for men. The level is among the world’s lowest, set in 1932 during the Stalin era.

Under the no-policy-change scenario, S&P Global Ratings predicts Russia will be among six sovereigns whose net debt levels will be above 250 percent of economic output in 2050 as a result of age-related spending and pension costs.

“Conservative policy making, like that of the Finance Ministry and the Bank of Russia, is indeed important for investors,” said Viktor Szabo, a London-based money manager at Aberdeen Asset Management Plc, which oversees $11 billion of emerging-market assets. “Aging itself is not good news, as it reduces the potential growth rate, which in the longer run makes fiscal sustainability more challenging.”

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