Russia Prepared to Handle Debt Sanctions But Borrowing Costs May Increase, US Investor Says

WASHINGTON (Sputnik) – The Russian government is prepared to deal with new US sanctions against its debt, however, the costs of borrowing will grow as a result, Director of Navigator Principal Investors Kyle Shostak told Sputnik.

Earlier in the day, the United States introduced new sanctions against Russia, which, in particular, prohibit US financial institutions from buying Russian government bonds (OFZs) during primary placements after 14 June. However, they will still be able to buy and sell Russian government bonds on the secondary market.

“[It] will result in the overall increase of the share of the Russian banks and ruble funds in the OFZ market thus replacing foreigners”, Shostak said. “So, the net impact on the borrowing costs may not be too dramatic as a result, albeit somewhat painful in the short run. While Russia has never prohibited investors from participating in its ruble bond market, over the last decade, this market has learned and adapted to mostly rely on the Russian domestic investor base. So, it is more of an image issue than a reliance on foreign investors and as such will be something that the Russian government may be prepared more or less well to handle”.

Shostak called the most recent move by Washington “unprecedented in modern financial history”, and warned that it will lead to several issues.

“So-called non-residents currently own about 22%, or $41 billion of $185 billion worth of ruble-denominated OFZs (bonds of federal borrowing). At its peak, foreigners’ share was approximately 34% of which were ‘pure’ foreigners”, Shostak noted. “Of the 22% of non-resident bondholders, about 15% is Russian money abroad, basically foreign branches of Russian banks. So, at this point, non-Russian non-residents control about 7% of the total amount of the OFZ market. Traditionally, half of that was owned by US funds”.

Shostak shared that he does not expect all investors to leave the market over the measure as some will continue to buy secondaries from primary dealers.

He believes it is highly likely that non-US foreign investors will replace the Americans.

Shostak went on to say that another implication of the new sanctions is that the measure will deter more compliance-cautious foreign buyers, who will opt not to “play with fire” under any circumstances.

“While it is hard to model the precise impact of their exodus, their fire sale may push the prices down and the yields up”, he added. “The overall costs of borrowing for the Russian government may increase as a result of the foreigners leaving the space”.

Asked about how the sanctions will affect the ruble, Shostak said, “The ruble will see more short-term volatility and may stay volatile until the exact impact of the new measure is fully known and priced in”.

“The net effect may be rather moderate, at least in the medium-to-long term”, he added. ” It’s not to be underestimated that the US government may be willing to keep the powder dry and be ready to implement a prohibition of secondary purchases should the first measures prove ineffective”.

The Bank of Russia said on Thursday it was monitoring the situation in the financial market after the United States imposed sanctions against Russian government debt, and will use all available tools to maintain financial stability, if necessary. The regulator noted that the share of foreign investors in the total volume of public debt and even more so in primary placements had significantly decreased over the past year.

The Russian Foreign Ministry said the US government’s actions are contrary to its declared intention to build pragmatic relations with Russia. The Foreign Ministry has notified US Ambassador to Russia John Sullivan that retaliatory measures by Moscow will be announced soon.

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