It is no exaggeration to say that when Russian Railways placed its first ever inflation-linked bond in July last year, every Russian CFO with their finger on the pulse of the capital markets asked their funding team whether it was possible and sensible for their company to do the same.
In most cases the answer was no. For these bonds to be useful to companies, revenues need to be strongly linked to Russian domestic inflation, as they are for Russian Railways.
But for the few issuers where this is the case, such the Federal Grid Company which has since placed its own bonds of this type, the new product marked an important step in the development of the domestic market.
“At the outset, inflation bonds were considered by the government as a niche instrument for financing infrastructure development as the source of funding is the long term pension proceeds,” says Pavel Ilichev, deputy head of corporate finance at Russian Railways in Moscow. “Pension proceeds are supposed to be invested in conservative and low risk instruments and infrastructure bonds fit this idea.”
When Baa1/BBB/BBB rated Russian Railways placed its first inflation bond, it invited a broad range of local pension funds to participate as well as the state pension fund Vnesheconombank (VEB), which is the biggest of them all, managing Rb1,600bn. The company sold Rb10bn of 10 year bonds at 210bp over the Consumer Price Index (CPI). This was considered to be the market clearing price for such paper.
But in order to support the product and the state owned companies, in October last year the government changed VEB’s investment declaration to allow it to buy up to 100% of issues printed by triple-B rated infrastructure companies. VEB can now invest up to Rb100bn of its pension proceeds in these inflation-linked bonds, and pricing of those bonds has been set at 100bp over CPI as part of the government’s support of the infrastructure companies.
The programme of these issues runs for three years on these terms — up to the end of 2015. As well as these infrastructure bonds, the government has also set a long term tariff policy for Russian Railways that will cover the costs of repaying this debt. Ilichev says that depending on its success in practice the programme might be extended further.
Russian Railways has already issued Rb50bn of CPI-linked bonds this year and intends to place a further Rb50bn-Rb100bn before the end of 2013. Next year Ilichev says the company may issue another Rb100bn, and in 2015 a further Rb100bn, though those plans will depend on the scope of Russian Railways’ investment programme.
International diversity
The company is also a frequent issuer in the Eurobond market. It has in the past placed Eurobonds in dollars, Swiss francs, roubles, euros and even sterling. Already this year it has sold Sfr525m 2018s, Sfr150m 2021s and €1bn 2021s. But the company does not plan to re-enter the international debt capital markets before the end of the year, either in syndicated loans or in bonds.
Russian rates cuts are expected soon because inflation slowed in August and yields have increased in the international markets as a result of the expected reduction of quantitative easing by the US Federal Reseve. Because of this, Russian Railways sees the domestic market as being the most attractive in the near future. But the increased appetite domestically may help spur on wider demand for the inflation-linked notes. Russian Railways is also eying the possibility of printing an internationally sold CPI-linked note, though that is a longer term plan.
“We anticipate growing demand for CPI-linked paper from commercial investors following the downward trend in central bank interest rates,” says Ilichev. “As regards to a potential issue of CPI Eurobonds, this might be an option to consider but it will depend on the price and maturity. A duration of more than 10 years in rouble denominated Eurobonds might be quite challenging.”
With demand for EM private placements also having recently increased, Ilichev is assessing the possibility of making more use of that market.
“We have looked at some niche commercial paper which can be issued in Germany for example and depositary receipts on our local bonds,” says Ilichev.
However, such instruments are usually available only in local currencies or dollars, for which he has limited appetite.
As ever though, Russian Railways is keen to innovate.
“But situation is changing, life goes on, so why not in the future?” he says.