Navalny Highlights Investors’ Black-Box Conundrum: Russia Credit

The conviction of Alexey Navalny, a
political opponent of Russian President Vladimir Putin,
highlights risks faced by investors as they weigh whether to buy
assets in the world’s biggest energy exporter.

Russia, which earned about $350 billion from oil and gas
exports last year, has a Baa1 rating at Moody’s Investors
Service, on par with Mexico. The level “reflects weak
governance, rule of law and transparency,” the firm said in a
July 19 e-mail. That hasn’t deterred investors, with ruble bonds
making 3 percent this year, compared with a 0.6 percent loss for
emerging-market peers, according to JPMorgan Chase Co. data.

The ruble tumbled the most in two weeks and Russian stocks,
already the cheapest among 21 emerging markets tracked by
Bloomberg, dropped the most in a month on July 18, when a court
sentenced Navalny to five years in prison for embezzlement. The
verdict sowed doubts about the rule of law in Russia, with U.S.
President Barack Obama’s spokesman, Jay Carney, denouncing the
conviction as part of a “disturbing trend” in Russia.

“Foreign investors see the political situation in Russia
as a black box, which is a big risk to the country’s future,”
Ogeday Topcular, a fund manager at Ram Capital SA in Geneva,
which has $300 million of assets, said in an e-mail on July 19.
“How much this risk is priced in is another question.”

Guilty Verdict

The yield on Russia’s benchmark February 2027 bonds jumped
six basis points, or 0.06 percentage point, to 7.6 percent on
July 18 before declining two basis points on the following day.
That compares with a two-day increase of five basis points in
the yield of Mexico’s 2027 security, whose yield stood at 6.11
percent on July 19. The rate on similar Polish notes fell 10
basis points to 4.21 percent.

Navalny was released from custody on July 19 while he
considers appealing the ruling. His sentence is a “negative
factor for the markets,” Russia’s Deputy Economy Minister
Andrey Klepach told reporters in Moscow on the same day.

“We don’t have reason to believe that the verdict of this
case can in any way affect the investment climate,” Dmitry Peskov, Putin’s spokesman, said in an interview on July 19. “On
the contrary, it won’t have any effect because in all countries
around the world there are high-profile legal cases.”

Capital Flight

On the day of the ruling, several thousand protesters
gathered for an unsanctioned rally near the Kremlin in support
of Navalny, who last year spearheaded the biggest protests
against Putin’s 13-year-rule. A Moscow court cut his sentence to
11 years in December. Police detained some demonstrators and
blocked off streets amid shouts of “freedom to political
prisoners” and “Putin is a thief.”

“I certainly disapprove of the way Putin handles political
opponents and, in the medium term and longer term, this line
will do little to attract foreign direct investment or stop
capital flight,” Michael Hansen, who helps manage about $1
billion in emerging-market debt as a senior strategist at Global
Evolution AS in Kolding, Denmark, said by e-mail on July 19.

Russia is ranked as the most corrupt nation among the Group
of 20 advanced economies in Berlin-based Transparency
International’s 2012 Corruption Perceptions Index. The
government’s capital outflow forecast for 2013 may be raised to
$50 billion, compared with $56.8 billion last year, Deputy
Economy Minister Klepach said on July 19.

Servicing Debt

Navalny is the latest prominent opponent to face prison.

Former Yukos Oil Co. owner Mikhail Khodorkovsky, 50, was
detained in October 2003. Once Russia’s richest man,
Khodorkovsky is serving a 13-year sentence. A Moscow court cut
his sentence to 11 years in December. At least two other high-profile critics — economist Sergei Guriev and former chess
grandmaster Garry Kasparov — have left Russia this year.

“While from a human rights perspective the sentencing of
Navalny raises serious concerns, it has nothing to do with
Russia’s ability to service its debt obligations,” Viktor Szabo, who helps oversee more than $10 billion in emerging-market assets at Aberdeen Asset Management in London, said by e-mail on July 19. “I don’t think it will have any market impact,
unless street protests turn violent, which given the weakness
and fragmentation of the opposition seems highly unlikely.”

The yield on Russia’s dollar bond maturing in March 2030
retreated two basis points to 3.738 percent at 11:40 a.m. in
Moscow. The extra yield investors demand to hold Russia’s dollar
debt rather than Treasuries fell one basis point to 206,
compared with 185 for Mexico, according to JPMorgan indexes.

‘Secondary’ Issue

Russia’s credit-default swaps, contracts insuring the
nation’s debt against default, was steady at 164 today,
according to data compiled by Bloomberg. This compares with 111
for Mexico’s CDS, while Poland was little changed at 89.

Putin, who started his third term as Russia’s president in
May 2012, vowed to sustain economic growth during his campaign,
reverse “repressive” policies and protect private business.

“Russia’s governance indicators are definitely poorer than
similarly-rated countries, this weakness is priced into the
rating already,” Charles Seville, a director at Fitch Ratings,
said by phone from London on July 19. “It’s part of the rating
but it’s secondary to the economic and public finance issue. It
would take a bigger event to change our view.”

To contact the reporters on this story:
Ksenia Galouchko in Moscow at;
Vladimir Kuznetsov in Moscow at

To contact the editors responsible for this story:
Wojciech Moskwa at;
Daniel Tilles at

Enlarge image
Opposition Leader Alexey Navalny

Opposition Leader Alexey Navalny

Opposition Leader Alexey Navalny

Vasily Maximov/AFP via Getty Images

Alexey Navalny, a political opponent of President Vladimir Putin, was released from custody on July 19 while he considers appealing the ruling.

Alexey Navalny, a political opponent of President Vladimir Putin, was released from custody on July 19 while he considers appealing the ruling. Photographer: Vasily Maximov/AFP via Getty Images

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