Western investors brush off ‘mild’ US bond sanctions on Russia

The Biden administration’s sanctions against Moscow sparked a brief wobble in Russia’s financial markets on Thursday, but foreign analysts and investors expect the country to dodge more lasting damage.

The rouble initially fell more than 2 per cent when news broke of the impending US sanctions, and the decision to bar US institutions from participating in new issues of Russia’s sovereign bonds brought a key risk hanging over Moscow’s markets to realisation.

But by the time markets closed, the currency had almost fully recovered, trading at just above 76 to the dollar. Fund managers say the new issue restrictions were likely the mildest action the White House could have taken against Russia’s debt.

“The devil you know is much better than the uncertainty,” said Viktor Szabo, investment director at Aberdeen Standard Investments. “The worst expectations did not materialise. It’s unpleasant but it’s not going to do anything to really shake the Russian economy.”

Battle-scarred after years of sanctions against Moscow, investors in Russian sovereign assets say high yields and the country’s low levels of debt still make the bonds some of the most alluring offerings in emerging markets. As the US declined to target secondary trading of Russia’s bonds, most of them are prepared to stick it out.

Russia’s finance ministry said on Thursday it would hold debt auctions “depending on market conditions” before the sanctions go into effect on June 14, then issue new debt only after ending secondary offerings of existing debt.

Moscow has made a show of force to indicate that its state-owned banks can make up for any lost foreign demand. VTB, Russia’s second-largest lender, bought 72 per cent of the most recent sovereign debt issue this week.

The sanctions are “a largely symbolic measure” that entrench “financial autocracy,” said Elina Ribakova, deputy chief economist at the Institute for International Finance. “Carrots are gone — there’s no way to roll back the sanctions — and the US is increasingly running out of sticks. Local banks will buy Russian debt on the primary [market] and sell it on to other banks and asset managers.”

In the short term, Russia may be forced to moderately cut back its borrowing plans and raise interest rates at the central bank’s next meeting, a week from Friday, said Sofya Donets, chief economist at Renaissance Capital. “They won’t have to do anything more radical, because [the sanctions] are something the market can still digest without any significant systemic risks to financial stability,” she said.

The move is the second set of US measures against Russian debt after Washington sanctioned Russian government foreign currency bonds in 2019. That prompted a gradual sell-off of all Russian state assets: foreign holdings of finance ministry-issued OFZs, which are denominated in roubles, fell from 35 per cent last February to 20 per cent this month, the lowest proportion in five years.

Nonetheless, the secondary market for Russia’s foreign currency bonds remains active, said Gustavo Medeiros, deputy head of research at Ashmore. “In the short term even non-US institutional investors will be shy from acting in the primary market,” he said. “However, after the dust settles and a new foreign policy equilibrium is found, non-US investors may participate in primary auctions again.”

The greatest threat to Russian assets, investors said, would be fresh geopolitical tensions that prompt the US to ban trading on the secondary market. “The risk is obviously the direction,” said Richard House, chief investment officer for emerging market debt at AllianzGI.

For now, however, Szabo said markets had not seen the level of selling that one would expect if investors were worried about sanctions targeting the secondary market.

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