What is happening with the OFZ market and whether Russia will be able to service the expensive government debt. Analysis

The main thing in the material:

— The yield on long-term government bonds exceeds 16%, despite the reduction in the key rate by the Bank of Russia. The Ministry of Finance has suspended OFZ auctions

— In such conditions, the main risk for the budget is not debt repayment, but an increase in the cost of servicing it as new placements and refinancing occur.

— The Ministry of Finance can reduce the volume of placements, use floaters and short issues more actively, but each of these tools has its limitations.

— Further market dynamics will depend on a steady slowdown in inflation, fiscal policy, and the Central Bank's willingness to continue the rate cut cycle.

At the end of July, after a series of refusals to place federal loan bonds, the Ministry of Finance suspended auctions indefinitely, explaining the decision by the need to stabilize the market. The yield on long-term government bonds now exceeds 16% per annum. At the same time, the government's long-term borrowings are not getting cheaper, even with a reduction in the key interest rate. Izvestia investigated why the market requires such expensive money and how the government will service the ever—increasing debt.

Expensive does not mean unbearable.

In the third quarter, the Ministry of Finance planned to receive about 1.5 trillion rubles from the placement of OFZ. There were 14 auction days planned. However, on July 1, the agency placed only 10.4 billion rubles, and on July 8 it canceled the auction, explaining the move by high market volatility. On July 15, the Ministry of Finance offered investors a float, but declined to place it due to a lack of bids at an acceptable price. Therefore, the decision taken on July 20 to suspend auctions until further notice no longer seemed sudden. Formally, the pause was explained by the desire to stabilize the market. But, in essence, we are most likely talking about the unwillingness to borrow funds at an interest rate that the agency considers excessive.

On July 27, the coupon-free yield curve of the Bank of Russia showed:

• 15.89% for a period of 10 years;
• 16.02% for 15 years;
• 16.09% for 20 years;
• 16.18% for 30 years.

For up to a year, the yield was below 14%.

Suspending auctions now is a tactical decision. As long as the Ministry of Finance does not come out with new placements, the pressure from the initial supply is decreasing. This may support the quotes of the issues already in circulation. So, at the trading session on July 20, the RGBI government bond price index was able to gain ground and closed at 111.62 points. The ministry's decision is able to support prices in the short term, but it does not change the fundamental assessment of long-term debt. It shows that there is a gap between the price acceptable to the state and the price acceptable to investors.

At the same time, the budget's need for financing has not disappeared anywhere: the Ministry of Finance simply postponed the deal in the hope of better conditions. And with a reserve of liquidity, such a decision does not look extraordinary.

The high profitability of OFZ does not mean that the government risks not paying off its obligations. The national debt is repaid using a refinancing mechanism — when new bonds are issued as the repayment period for old bonds approaches, which provide an influx of funds for settlements. In addition, old OFZS with a fixed coupon continue to be serviced according to the conditions established when they were issued. The revaluation of the debt value is gradual, so the situation does not look like an instant debt spiral yet.

But the longer new securities have to be placed at high rates, the more future budget revenues are reserved for interest payments. This process is developing slowly, but it has a cumulative effect: even if the Central Bank's rate and market yields decrease, coupons for already placed issues will remain high until they mature. Therefore, the main question now is not that the state will not be able to repay the debt (the probability of such a scenario in the current conditions looks low), but how much resources will have to be allocated annually to service it and whether interest costs will begin to displace other budget items.

Most of the Russian government debt is denominated in rubles and located within the country. This reduces the currency risk and the likelihood of a classic external default. By the end of 2025, the domestic debt reached 30.7 trillion rubles and accounted for more than 87% of the total national debt. At the same time, almost all of it is represented by OFZ. That is why government bond yields actually determine the cost of new federal budget borrowings.

For 2026, the maximum volume of placement of ruble-denominated OFZs is set at 6.47 trillion rubles at face value. This does not mean that the Ministry of Finance will necessarily place the entire volume, but it shows the potential scale of the proposal.

If we very roughly assume that the entire volume of quarterly borrowings — 1.5 trillion rubles — would be placed at a yield of about 16% per annum, then annual interest payments on these issues could amount to about 240 billion rubles. This is not a forecast of real budget expenditures: the total cost of borrowing depends on the maturity, coupon size, placement price, and repayment schedule. However, such an assessment shows the scale: even reducing the average placement yield by just one percentage point saves the budget about 15 billion rubles in interest payments per year with such a volume of borrowings.

Therefore, for the Ministry of Finance, canceling auctions may be more economically profitable than successfully placing at too high a bid. If the agency expects a further decline in market yields, a few weeks of waiting can save the budget tens of billions of rubles on servicing new debt over the entire life of the bonds.

The displacement effect

The high yield of government bonds affects not only budget expenditures. It sets the minimum price of money for the entire financial system. OFZs are considered a basic ruble instrument with a relatively low risk. Therefore, large investors, such as banks, compare their yields when choosing between government and corporate bonds. If the government already offers about 16% per annum on long-term securities, it makes no sense for an investor to lend to a private company at the same 16%, since the risks there are higher. As a result, in order to raise money, a corporate borrower must offer an additional risk premium to the investor. Then, for some companies, issuing bonds or obtaining a long-term bank loan makes no economic sense. This is how the government begins to compete with the private sector for the same amount of free money. In economics, this mechanism is called the crowding out effect: government borrowing partially displaces private investment.

As a result, companies are postponing modernization, construction of new facilities, purchase of equipment and entry into new markets, as projects that were profitable at a loan cost of 10-12% may turn out to be unprofitable at a rate of 18-20%. Thus, high OFZ yields increase the cost of capital not only for the Ministry of Finance, but also for the entire economy. The longer this structure persists, the weaker the investment activity and the lower the potential economic growth rate. A vicious circle is emerging: weak economic growth limits the increase in tax revenues, debt servicing costs continue to rise, the budget may need even more borrowing, and large volumes of new issues may support high yields on OFZs.

Why can't the Central Bank save the OFZ market

On July 24, the Bank of Russia lowered its key rate by 25 basis points to 14% per annum. The regulator noted moderate economic growth in the second quarter, but at the same time pointed to an increase in inflation expectations and maintained a cautious approach to further easing policy. At first glance, it is the rate cut that should increase the attractiveness of already issued bonds with high coupons — their prices are rising and yields are declining. Then the government can return to the market and borrow more cheaply. However, this logic does not always work with long OFZs. The buyer of a thirty-year bond does not assess the rate at the next meeting, but the average inflation and monetary policy for decades to come. If an investor expects that a rate cut today will cause a new price increase tomorrow (which will lead to a reversal of the Central Bank's policy), he will demand high yields on long paper even with policy easing.

When the Central Bank raises or lowers the key rate, it primarily affects bank lending. Expensive loans cool demand: the population borrows less to buy housing and large goods, companies are more cautious about launching new investment projects. It is through this mechanism that the regulator is trying to contain inflation. But there is also a second channel through which the state influences economic activity— budget expenditures. By paying salaries to state employees, financing public procurement, infrastructure projects, and social benefits, the state is pouring money into the economy. The incomes of companies and the population are growing, which means that demand is maintained even in conditions of expensive bank loans.

At the same time, the timing and speed with which these funds enter the economy is important for monetary policy. According to the preliminary estimate of the Ministry of Finance, in the first half of the year, the federal budget deficit amounted to 5.7 trillion rubles (revenues — 18.62 trillion, expenses — 24.35 trillion rubles). At the same time, the law has planned a deficit of 3.8 trillion rubles. The Ministry of Finance explained the outstripping increase in expenses by promptly concluding contracts and paying advances (further, the budget can partially restore the balance due to tax revenues, so the deficit of the first half of the year cannot be mechanically doubled). This means that many companies have received budget funds earlier than usual, started fulfilling government contracts, paid salaries, and settled accounts with suppliers.

If at such a moment the Central Bank sharply lowers the rate, then bank lending will revive. Then two sources of demand — budget and credit — begin to operate simultaneously. If enterprises are able to quickly increase output and increase imports, additional liquidity can be absorbed without a noticeable increase in prices. But if the economy is already operating at high capacity utilization, and import channels are limited, increased demand is reflected more quickly in prices. Therefore, the Bank of Russia is acting cautiously so as not to increase inflationary pressure. If the Central Bank sharply reduces the rate, the yields of short-term OFZs may also decrease, however, with high inflation expectations, investors are likely to maintain high demands on the yields of long-term securities. As a result, the yield curve will become steeper, and the cost of long-term borrowing for the government will remain high.

The market is well aware that a single rate cut or increase is not enough to achieve the inflation target. And until he believes in its steady slowdown and a reduction in budget pressure on the economy, long-term bond yields may remain high.

Getting out of the debt trap

The situation is not hopeless. If fiscal policy becomes less stimulating, inflation will steadily slow down, output of goods and services will increase (if supply grows faster than demand, additional liquidity affects prices less), tax revenues will increase, the budget deficit will decrease (and the economy will need less new borrowing), investors will begin to accept lower yields on long-term OFZs.

The government doesn't have a simple solution right now. The Ministry of Finance can wait out the volatility and return to auctions. But it works if the current sell-off was caused by a temporary shock and the market recovers quickly. You can also increase the share of floaters (their profitability depends on the RUONIA rate, which almost mirrors the key rate), but if the rate remains high for a long time, debt payments will also increase. Another way is to use accumulated reserves, reduce expenses, or raise taxes. This will reduce the government's need for new loans and ease pressure on the debt market, but at the same time may contradict current economic and political priorities.

It is most likely that the Ministry of Finance will combine several solutions at once: to pause auctions, postpone some of the placements to a later date, make more active use of floaters and short OFZ, as well as redistribute available budgetary resources. This approach will allow us to maintain flexibility in managing public debt. However, none of these tools solves the problem completely. Now a lot depends on how stable the slowdown in inflation will be and whether the Bank of Russia will be able to continue reducing the key interest rate. In the meantime, a long yield of 16% is the price of uncertainty, which market participants are not ready to ignore.

The theses contained in the text are not an investment recommendation, but the opinion of the editors.