Vladimir's headache

Soviet Bonds Are Haunting Putin
 

Businessweek

6 September, 2012

Soviet bonds issued in 1982, Leonid Brezhnev’s final year in power, are threatening the finances of Vladimir Putin’s Russia. Investors and pensioners are pushing Moscow to honor its mid-1990s promise to account for Soviet-era pension guarantees and other liabilities, including bonds. There are no public records describing the exact number or value of the bonds sold, but the government estimates that it needs 25 trillion rubles ($785 billion) to account for what remains of the Soviet balance sheet. That liability equals almost half of Russia’s economic output and would boost government debt nearly tenfold, according to Vladimir Osakovskiy, chief economist at Bank of America Merrill Lynch in Moscow. Although Putin has stalled redemptions of Soviet bonds, most recently in April with an order to halt payments until 2015, recent international court rulings have given bondholders fresh ammunition to pursue claims.

Former Soviet states like Kazakhstan forced bond investors to accept a fraction of what they were owed shortly after the USSR dissolved, but Russia vowed to eventually make good on its debts at 1990 levels, says Boris Kheyfets, a Soviet debt specialist at the Russian Academy of Sciences’s Institute of Economics in Moscow. “This all should have been settled back in the 1990s,” Kheyfets says. “How do you assume a debt that huge? It would collapse everything immediately.”

The first wave of bond payouts came during Putin’s first term, when Russia was riding a surge in oil prices to a budget surplus. Now, with a swelling pension-fund deficit, Russian government finances are strained. Putin warned a meeting of regional human rights officials last month that clearing all Soviet-era debts immediately would mean having “nothing left to pay salaries to soldiers, to doctors, to teachers.”

The government earmarked 50 billion rubles for repayment in this year’s budget, and the same for 2013 and 2014. Putin said last month that the Ministry of Finance should continue its system of gradual payments to the most elderly creditors. Those who die are eligible for 6,000 rubles, less than $200, in funeral costs. The European Court of Human Rights in Strasbourg, France, found that approach niggling, and ordered the state in July to pay Moscow-area septuagenarian Yuriy Lobanov €37,150 ($46,497), or about 140 times the average monthly pension, for his 1982 notes. In its decision, the court cited Russia’s refusal to say how many of the bonds are outstanding and its repeated suspensions of redemptions “for reasons that remain unclear to the court.” Mariya Andreyeva, a 95-year-old survivor of the Nazi blockade of Leningrad, won a preliminary ruling awarding her €4,300 on her bonds.

Russia has avoided paying out claims following similar court challenges, but the Lobanov decision used domestic Russian legislation and the lowest possible interest rates to calculate the amount owed, leaving little room for rebuttal, says Vasily Vasilyev, a lawyer at Yukov, Khrenov & Partners in Moscow. “The government had nothing to challenge, since there were no other government documents on the matter,” Vasilyev says, calling the ruling “very sound.” The Ministry of Justice said in a statement that it honors all judgments by the European Court of Human Rights, but added that the Lobanov ruling only applies to the 1982 notes. The Finance Ministry declined to comment.

Russia returned to international debt markets two years ago, following a 12-year hiatus prompted by its default on $40 billion of domestic debt in 1998, in the aftermath of the Asian financial crisis. The government plans to open the domestic market for ruble-denominated corporate and sovereign bonds through international depositaries Euroclear Bank and Clearstream International later this year.

The year before its debt default, Bank of America’s Osakovskiy says, Russia settled outstanding tsarist bonds in France for $400 million, a 99 percent haircut. “We expect a similar settlement” with the Soviet-era bonds, says Osakovskiy. Putin will likely only end the payment freeze if a group with enough political clout starts amassing the bonds, says Saleh Daher, managing director at Turan, which has invested in Soviet commercial debt. “People will make money from this,” says Daher. “And I doubt very much that much of it will go to the pensioners or the people who actually had the claims in the beginning.”

The bottom line: Repaying all of the Soviet debts it has assumed would cost Russia almost half of its economic output.