BARCLAYS: Emerging Markets Research: Russia - local fixed income market - opening the door to Russia's OFZ market
Summary: Opening the door toRussia’s OFZ market
The process of making local RUB denominated government bonds (OFZ) suitable for trading and settlement on Euroclear has reached its final stage. Barring hiccups, foreigners should be able to trade OFZ on the system by early next year. We update our previous analysis (RussiaLocal Markets: Liberalisation brings opportunity, 27 February 2012) on the impact this could have on foreign inflows, OFZ yields and the currency.
Attractive yields of around 7% and low public debt (9% of GDP) make OFZs appealing, in particular as global fund allocations continue to shift intoEM debt. Atthe same time,Russia’s monetary policy is becoming more supportive for local rates markets, as it focuses on inflation targets, allowing for more RUB flexibility and using interest rates as the main policy instrument.
We see big potential for the OFZ market to catch up from its currently small foreign ownership base and still underweight positions by EM bond investors. We estimate USD25-40bn of foreign flows into the OFZ market over the next two years, which would raise the share of foreign ownership in Russia’s market closer to the average for foreign holdings in local EM bond markets.
Foreign flows into EM local markets have typically been associated with a deeper market and lower longer-term yields (as premium declines). On the back of the rally we have already seen in recent months, we estimate a further compression of long-end yields by about 80bp over a one-year horizon, although this can be frontloaded.
Increased OFZ-related foreign portfolio inflows would also support the RUB, in our view, pushing it towards the lower end of its post-financial crisis trading range. In our baseline, we forecast USD/RUB at30 in12 months’ time but see the potential for more appreciation.
To best benefit from such developments, we recommend positioning in OFZ with 10- 15y maturities, FX unhedged. We particularly like the Feb’27, currently yielding 7.4%. We expect this yield to decline to around 6.6%, as we forecast the OFZ yield curve to decline and flatten in 2013.