Bond Sanctions Could Hurt Russia More Than It's Letting On

(Bloomberg) -- Russian officials say they’re not worried about possible new U.S. sanctions on the country’s sovereign debt. Economists aren’t buying it.

Borrowing costs will rise by between 50 basis points and 150 basis points if the U.S. extends sanctions to bar its citizens from buying new Russian domestic government debt, according to the majority of respondents in a Bloomberg survey. The Russian central bank estimates yields will stabilize 30 basis points to 40 basis points higher after an initial spike.

Officials in Moscow are downplaying the impact of what M&G Ltd has called the “nuclear option” for U.S. relations with Russia, insisting that there is enough local demand to replace foreigners who currently hold a third of outstanding debt. Investors are growing concerned about the threat ahead of a report due to be published by the U.S. Treasury next quarter on the potential consequences of sanctioning Russian sovereign debt as punishment for alleged meddling in last year’s elections.

“New anti-Russia sanctions may totally stop other foreign investors, not the U.S. investors only, from buying the new government debt, fiercely pushing up borrowing costs for Russia,” said Vladimir Miklashevsky, a senior economist at Danske Bank A/S in Helsinki, who thinks bond yields would climb more than 200 basis points. That’s the “main psychological constraint” weighing on investors at the moment, he said.

Yields on ruble bonds maturing in 2027 have recovered some ground after jumping to an 11-week high in mid-November, and were trading at 7.59 percent on Monday. A 150 basis-point increase would push borrowing costs to a level not seen since May 2016, whereas the central bank’s projected 40 basis point increase would take yields to a seven-month high.

Russian state-owned companies that were barred from issuing new bonds under sanctions imposed by the U.S. and European Union in 2014 have adapted by cutting back spending and buying back existing debt. Those penalties didn’t restrict the government’s ability to sell bonds.

The government largely relies on ruble debt sales to cover its budget shortfall, which this year is expected to be about 2 percent of gross-domestic product. The Finance Ministry is using a recent jump in oil prices to build out its reserve funds with excess energy revenues and aims to balance its books by 2020.

Deputy Finance Minister Vladimir Kolychev said in an interview on Nov. 8 that the cost of debt servicing for the budget will rise “insignificantly” in the event of sanctions and the ministry is ready for a jump in yields. Demand for bonds from the banking sector will ensure there “won’t be any seriously negative consequences,” central bank Governor Elvira Nabiullina said in a speech in Russia’s parliament just over a week later.

Roman Ermakov, an analyst at Lanta-Bank in Moscow, who forecasts that the sanctions would add as much as 120 basis points to Russia’s borrowing costs, says demand from local participants will only cover about 70 percent of the gap left by foreigner investors.

“The initial sell-off will be more severe, but the government will likely limit the impact by tightening fiscal policy and reduce its borrowing needs,” said Per Hammarlund, chief emerging-markets strategist at SEB in Stockholm.

©2017 Bloomberg L.P.