* Russian rouble govt bonds to be settled internationally
* Move may attract $30-$50 billion in foreign cash by 2014
* Low debt burden, falling inflation, add to bonds' appeal
By Jason Bush
MOSCOW, March 22 An overhaul of Russia's domestic government bond market is poised to attract tens of billions of dollars in foreign cash, as Russia seeks to make its paper accessible to heavyweight Western institutional investors.
By enabling its locally issued treasury bonds - known as OFZs - to be settled through international clearing houses, Russia is in the process of sweeping away regulatory barriers that have kept most foreign investors away.
The liberalisation means that Russia will belatedly tap into an international fashion for local currency debt, which has mushroomed in recent years as investors seek out alternatives to the low yields on dollar bonds.
"The implications are revolutionary," said Dmitry Dudkin, head of fixed income research at Uralsib Capital in Moscow.
The new rules could trigger an additional $30-50 billion in foreign investment into the rouble bond market by the end of 2014, Barclays Capital estimates, as foreign participation rises towards levels typically seen in other emerging markets.
"The mass of money that can shift is very large," said Christian Keller, emerging Europe research head at Barclays Capital.
"You now have an opportunity of a market that has attractive yields, good debt dynamics, and has been under-appreciated."
Although Russia's public finances have been transformed since it defaulted on $70 billion of domestic debt in 1998, few foreigners have subsequently braved its local bond market.
They have been deterred by cumbersome rules requiring accounts with local brokerages, as well as lengthy settlement procedures and outdated custody laws.
Of the $90 billion in OFZs outstanding, only around 4 percent are owned by foreigners - well below the shares seen in most other emerging markets, which range from around 11 percent in Brazil to more than 40 percent in Hungary.
"We have the feeling that the majority of foreign investors are way, way underweight Russian local bonds, because of not being able to gain exposure," said Viktor Szabo, who helps manage around $7 billion in emerging market debt at Aberdeen Asset Management in London.
Several changes this year should transform market access.
In January, Russia removed a monopoly on OFZ trading enjoyed by Russia's MICEX exchange.
Russia has also reached a deal with Clearstream, one of the two major international Eurobond clearing houses, to settle OFZs from this month. The other major clearing system, Euroclear, is due to begin OFZ settlement in the second half of this year.
Russian legislation comes into force in July that will recognise investors, rather than local custodians, as the beneficial owners of the bonds, enabling conservative Western investors such as pension funds to buy OFZs.
"All of a sudden there's this market that no one's been involved in: everyone wants to try and grab a piece of the action," said Werner Gey Van Pittius at Investec in London, which manages $10 billion in emerging market debt.
HEALTHY FINANCIAL POSITION
Strong international demand for OFZs can also be expected because of relatively high yields, which look attractive given Russia's healthy financial position and falling inflation.
"We really like the Russian local bonds," said Van Pittius of Investec, which already invests in the market through local accounts opened last year.
He noted that yields on OFZs - around 8 percent for 10-year bonds - compare with around 4 percent on equivalent dollar-denominated Russian Eurobonds.
The ratio of Russian government debt to GDP is around 10 percent, and Russia is a net international creditor once its $150 billion in fiscal reserves - held in two rainy-day funds that gather windfall energy revenues - are taken into account.
Inflation, which hit a record low of 3.7 percent in February, is on a downward trend as Russia's central bank shifts from managing the exchange rate to inflation targeting, limiting money supply growth.
Some bond investors are nevertheless wary of the risks involved in Russia's oil-dependent economy.
"Most of the concerns we have with Russia are more long term: the potential growth rate, the lack of investment, the over-reliance on the commodities sector, and the vulnerability of the budget that arises from that," said Szabo at Aberdeen.
He also noted that the large foreign demand will be matched by large amounts of bond issuance, making the medium-term impact on bond yields unpredictable.
Russia plans net OFZ issuance of around $50 billion annually until at least 2014, more than doubling the size of the market.
But this also explains Moscow's concerted efforts to smooth access for foreign investors.
"Any changes that increase transparency, add to liquidity, reduce transaction costs and make the settlement of the bonds easier should help," said Paul DeNoon, who manages around $20 billion in emerging market debt at U.S. asset management giant AllianceBernstein in New York.
"So this is a positive step forward for Russia."