Article by Georgiy Neyaskin. Translation by Nick Trickett.
At the end of February, the Ministry of Finance unveiled parameters for the issuance of “people’s bonds” – debt instruments aimed at mobilizing household money for state needs in return for relatively high and risk-free returns. MinFin expects to get people’s money “out from under the pillow” (in all fairness, it should be noted that Russians prefer mattresses) declared director Anton Siluanov, who himself promised to buy securities in the first issuance scheduled for April.
The state is taking a cautious approach to the public’s money. The history of mass investment in Russia includes decades of negative experience connected to both voluntary and forced tithing of income through government bonds in the Soviet period, the collapse of private financial pyramid schemes and the state’s default in the 1990s, the disastrous “people’s” IPO of VTB Bank, and the “freezing” of the system of mandatory pension savings in the recent past. What’s the meaning of the most recent initiative by the authorities and are federal loan bonds actually attractive for investment?
Why is the government doing this?
International sanctions against Russia have forced authorities to think more about internal sources to top off the budget. Households could be the largest source of capital. By early January, Russians had accumulated 33 trillion rubles in national currency (which includes bank deposits, securities, and cash) as well as foreign currency deposits, according to data from Rosstat and the Bank of Russia. This sum is equal to two years of expenditures of Federal budget expenditures and six times the volume of the Reserve Fund and National Welfare Fund combined.
Where do Russians keep their savings now?
If you add foreign currency deposits to ruble savings, 56% of the resulting amount is held in ruble deposits in banks, with another 18% in foreign currency deposits. Russians save around 14% of their money “under the pillow” in rubles, and the remaining 13% in securities, including in this case standard “non-people’s” government bonds (OFZs).
How have investment preferences changed?
From January 2015 to January 2017, investments in securities saw the strongest growth (57%). Then came ruble (35%) and foreign currency (20%) deposits. The former became attractive after the sharp rise in the Central Bank’s key rate at the end of 2014 and the jump in bank deposit yields, the latter due to the stability of dollar and euro exchange rates compared to the much-weakened ruble. Savings in rubles grew all of 5% over the last two years. There are cash savings in foreign currencies, but they’re harder to count – the Central Bank reported that on the 1st of October, Russia’s “other sectors” (which includes the population) had currency worth as much as 2.5 trillion rubles – less than 10% of total savings.
Cash savings of Russians (Trillions of rubles, beginning of month)
How profitable will the “people’s bonds” be?
The yields will grow from 7.5% to 10.4% until they mature: the longer they take to mature, the higher the yield. The average yield 3-year yield (the maximum issuance time for these Federal bonds) is 8.5% APR, according to the Ministry.
Are they more profitable than bank deposits?
If the yields amount to what’s been promised, yes. In December, the average rate for ruble deposits from 1-3 years stood at 7.6% APR, and analysts polled at RBK in February don’t expect growth this year.
Promised Yield, “People’s Bonds” vs. Short-Term and Long-Term Deposits
Aren’t OFZs More Profitable?
Basically, yes. Russians can lend to the Russian Federation without waiting for the April issuance, through normal market Federal bonds, which are bought by professional investors. The most convenient way to do so is open an individual investment account (IMA) with tax incentives. IMAs allow individuals to buy securities and entitles them to a refund of part of the taxes on income from the owner’s account not connected to investments (for example, the 13% personal income tax from salaries). The maximum contribution to the IMA subject to tax deduction is 400,000 rubles a year. In this case, the tax deduction for the personal income tax can reach 52,000 rubles. To return the tax, you need to hold the money in the account for three years.
An important difference between standard bonds and people’s bonds is that the former are traded on the secondary market and their yield can change. The estimated yield of standard, three-year Federal bonds is currently .5% lower than people’s bonds – around 8%, according to Anton Siluanov. But now standard bonds are traded on the market at similar yields to people’s bonds around 8.5% (8.4% for securities maturing in 2023 and 8.48% for securities due in 2019).
The tax deduction for personal income tax makes investment in standard bonds even more profitable. If someone filled the investment account one time to the maximum tax deduction of 400,000 rubles and kept the money in standard bonds at a rate of 8-8.5%, then the YTM on the investment would be 12-13% APR. If in the second and third year, the person keeps replenishing his account and receiving new deductions from these accounts, yields could grow to 15% APR. The maximum sum invested in this case is 1.2 million rubles, from which for you can get a deduction of 156,000 rubles over three years. Conclusion: investments in bonds through an IMA with a tax deduction can be more profitable than a “people’s” counterpart.
In the example, we didn’t take into account the inevitable commissions for brokers who open accounts in the interests of individuals. Middlemen can keep a percent from transactions with securities and a commission on annual services for the account. But, as a rule, we’re talking about tenths of a percent.
What are the pluses and minuses of people’s bonds?
Unlike an investment, people’s bonds have to be bought for at least one year, otherwise the coupon paid twice a year will be lost. The state guarantees the return of the nominal value of the securities: if you bought bonds for 50,000 rubles, that 50,000 has to be returned to you, whether in a day or in a few years. Another argument for using people’s bonds is the higher cap on investment. Each citizen can buy bonds from 30,000 to 25 million rubles over the course of each issuance. The Ministry of Finance promises to make no less than two issuances a year. This is several times greater than the maximum amount of a bank deposit for which there is a guaranteed return in case of bank failure – 1.4 million rubles. The amount from which you can get beneficial tax deductions per the IMA is less than that – 400,000 rubles per year.
Standard bonds are worse than people’s bonds in that you can’t redeem them within 3 years. On the other hand, standard bonds can be sold on the secondary market, while people’s bonds will be registered and can only be given over by bequest or returned to the state at par.
Opening a brokerage account to buy bonds won’t be more complicated than opening a deposit, according to Anton Siluanov. You will be able to buy people’s bonds through two state banks: Sberbank and VTB24.
Can the state deceive buyers of people’s bonds?
In Russia, everything is possible, but in this case, the government will be less tempted to make such maneuvers due to the small volume of issuances. The Ministry of Finance is planning to issue 20-30 billion rubles of people’s bonds a year. This is 1-1.5% of the 2 trillion rubles Russia plans to borrow in the present year, or about 1% of the deposits Russian banks drew from individuals in 2016. According to the Ministry of Finance, the basic goal of the issuance is not so much to replenish the budget as it is to instill financial literacy and a culture of investment in the population.