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25.04.2008 - MDM Comment: Russia and CIS debt market

Eurobonds: RUSSIA 30 is tightening below 150bp spread wise, as sell-off in US Treasuries continues. In corporates yesterday we saw volatility in TMENRU issues, which finished the day higher, despite the official denial of the rumours of Gazprom/TNK-BP alliance (see brief comment below). New VimpelCom issues are trading slightly above par.
Ruble bonds: Sentiment in local bonds remains moderately positive as money market rates stay low amid a tax payments period. That’s largely because of the increased capital inflow and intensified FX interventions by the Central Bank.
First Deputy Chief of the Central Bank A.Ulyukaev spoke yesterday on inflation, rates, capital inflow and state support of the banking system (see our commentary on page 2).
Russian shareholders of TNK-BP (Baa2/BB+) have officially denied the Gazprom’s bid for the company. Alfa/Access/Renova consortium has also reiterated that they don’t plan to reduce their exposure to the oil company (Source: RIA Novosti). We believe that the controversial news flow around TNK-BP will continue. It may include reports about the company’s conflicts with regulators as well as new rumors on a potential M&A-deal with Gazprom. On the back of that TMENRU issues are likely to behave quite volatile.
EuroChem (NR/BB-/BB-) is eyeing to buy a 50% stake in a Kazakh-based producer of phosphate fertilizers. Size of the deal is unknown but estimated at around USD 400 million (Source: Vedomosti). We think that EuroChem is in good shape to make acquisitions up to 1.0-1.5 billion in size without material damage to the credit profile. At the beginning of 2008 the company had over USD 600 million in cash balances and around 550m in debt. Its EBITDA in 2007 reached almost USD 1 billion.
UK-based car retailer Inchcape Plc. (NR) officially announced acquisition of 75% of shares of a Russian auto-dealer Musa Motors (NR). Total consideration payable may reach USD 450 million. We view the deal as yet another confirmation of strong equity appetite towards Russian retail and the car segment specifically. There are 5 auto dealers currently represented in the bond market (Incom-Lada, Avtomir, Atlant-M, all trading around 13-15%) and Rolf group with its debut Eurobond (9.0% to maturity in 2008).
Page 2. Mr. Ulyukaev’s testimony
The first deputy chairman of Russia's Central Bank, Alexei Ulyukaev, yesterday had its testimony in the Parliament on the Bank's monetary policy. Although we have already heard many of the points he made, we believe they are still attention worthy. Below is what he said (based on Reuters and Interfax reports):
a) Inflation is a concern, but Mr. Ulyukaev hopes it will be held to single digits in 2008. The Central Bank will gradually move to "inflation targeting", i.e. controlling inflation with rates; however, fully-fledged inflation targeting will only be possible in around 3 years as Russia's current account becomes more balanced and the ruble is unpegged.
b) When responding to questions, Mr. Ulyukaev did not rule out either ruble appreciation or rate increases in the short-term.
c) Mr. Ulyukaev sees signs of the economy overheating and does not think that the state’s cash coffers should be used as a source of funding for the banking system (perhaps referring to the latest banks’ lobbying efforts; they are asking for even more benign terms of MinFin's recently launched cash sale auctions).
d) Mr. Ulyukaev confirmed that in April Russia experienced a capital inflow after the outflow of the 1Q, and for the first time in months the Central Bank's FX interventions were material: It purchased in excess of USD10 bn.
We think that the most intriguing out of the above is Mr. Ulyukaev’s admission that ruble appreciation is possible. To remind, already for a few months the Central Bank’s officials have been referring to this anti-inflationary measure as inefficient. In fact, the illustration of this inefficiency was exactly yesterday – Mr. Ulyukaev’s words triggered a massive selling of FX, and the regulator had to buy around USD 5-6 billion, further flooding the system with liquidity and adding to the inflationary pressures.
We tend to believe that Mr. Ulyukaev “not ruling out ruble appreciation” doesn’t mean that ruble will be allowed to strengthen. He perhaps simply intended to say that nothing can be fully ruled out.
Instead, it is our belief that rate increases are now quite likely. If and when such actions take place, we believe the Central Bank's ‘bid’ for liquidity (short-term deposit rates) will actually be increased to a greater extent vs. the offer for liquidity (repo rate) as the Central Bank will want to narrow its “interest rate band”.
We entirely agree with Mr.Ulyukaev that budget cash should not be used to fund the banking system. As we said in our earlier comments, the government should instead try and move real interest rates into positive territory to facilitate an increase in household and corporate savings and to ultimately arrive at a more balanced financial system.
And finally, in our view, the single digit inflation target for 2008 looks too optimistic – we are already approaching 6.0% year-to-date.
When it comes down to implications for the ruble bond market of Mr. Ulyukaev’s speech, we tend to assign greater weight to the negative news (potential rate increases) vs positive ones (capital inflow, ruble).
From a balance sheet perspective, Gazprom can certainly afford such an acquisition without material damage to its credit profile – the group's EBITDA in 2007 approached USD40 billion – while consolidated net debt stood at approximately USD25 bn as of 1 October 2007.

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25.04.2008 13:49