Russia has a big borrowing problem, and the government just hit pause on one of its main tools for solving it.
The Finance Ministry announced it is halting auctions of OFZs - that is short for a type of Russian government bond - after a string of failed sales. Investors simply were not showing up with bids the government found acceptable.
On Tuesday, the main government bond index did increase following the ministry's auction halt announcement, but it remains roughly 1.2% lower since July began, according to Moscow Exchange data.
This is not the first time Russia has done this. In 2022, with the central bank's key rate at 20%, the government halted bond auctions for seven months because the invasion of Ukraine had driven up the cost of borrowing too much. Bond sales resumed about seven months after that.
Given the escalating expenses of the conflict in Ukraine, OFZs have become an essential financing tool for the Russian government. With rates now at 14.25% and the government's deficit ballooning, the standoff between the finance ministry and investors reflects deeper strains in Russia's war economy.
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The central bank's key rate sits at 14.25% as of June 19. For the past year, the bank had been gradually cutting rates, giving the government more room to borrow at reasonable costs. But that run may be over.
The central bank has signaled that there is less room for further cuts, and uncertainty is growing about whether it will keep lowering rates at all. The majority of analysts predict that the central bank will keep rates steady at the July 24 meeting, but investors continue to price in a significant chance of an increase.
Meanwhile, the government's need for cash is getting bigger. Russia's initial budget plan set a deficit target of 3.8 trillion rubles for the year, but the deficit has already climbed to 5.7 trillion rubles in the first half of the year, representing about 2.5% of GDP. The war in Ukraine is driving up spending faster than expected, and the government has a total financing program of 5.5 trillion rubles for the year. Around 4 trillion rubles are expected to come from OFZ sales, the National Wellbeing Fund, and proceeds generated by privatizations.
Ekaterina Vlasova, an economist at Bloomberg Economics, put it plainly. "The issue is not Minfin's ability to issue debt, but its ability to issue on acceptable terms."
During the previous suspension in 2022, the central bank had raised rates to 20% in response to financial turmoil following the invasion, and bond sales only resumed after rates were cut significantly. The current standoff echoes that period, though rates are lower at 14.25%. The National Wellbeing Fund, which holds oil revenues, has been tapped to cover deficits, but its resources are finite, adding pressure on the bond market.
The big date is July 24, when the central bank announces its next rate decision. That outcome will set the tone for whether the bond market can recover or whether the suspension drags on.
To cover the extra financing required due to larger-than-anticipated budget shortfalls in 2023 and 2024, the government will probably turn to alternative funding or floating-rate notes, according to Dmitry Polevoy, who serves as investment director at Astra Asset Management in Moscow.
Polevoy described the suspension as a necessary breather.
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