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MOSCOW (Reuters) - Political turmoil in South Africa and Turkey is luring money managers away and into Russian securities, complicating Moscow authorities' battle to tamp down the rising rouble.
By February, foreigners' share of the rouble bond market had already risen back to early-2013 highs of 28 percent, according to central bank data. But momentum has escalated since: JPMorgan's monthly client survey found the increase in rouble debt positions in March the largest on record.
Falling inflation, 8 percent yields and a central bank keen to keep interest rates relatively high are the main draw. But since March 27, the Russia trade has received fresh impetus to go along with that it has already been getting from Turkey's upheaval.
South Africa, another big emerging market, has plunged into political chaos, leaving it on the brink of joining Russia as a junk-rated credit but with the added drawback of a large balance of payments deficit.
S&P has already cut South Africa from investment grade and Moody's is considering it.
"Russia doesn't have the political instability that's afflicting Turkey and South Africa, or their weak fundamentals. It's helping Russia that other mainstream high-yielders are having their own problems," said Salman Ahmed, chief global strategist at Lombard Odier.
JPMorgan said it had cut allocations to South African debt and currency, adding: "Political risks remain in Turkey as well, so we choose to express (preference for high-yield bonds) solely via an overweight Russia in our (global bond index emerging markets) model portfolio."
Russia's central bank, meanwhile, has won praise for dogged inflation targeting. Slowing price growth has left real -- or inflation-adjusted -- bond yields at almost 400 basis points, a magnet for foreign investors in search of yield.
Finance Minister Anton Siluanov this week said Russia had received overseas inflows during the first quarter, despite capital flight of around $5 billion in January-February.
That inflow may accelerate, if Russia picks up even a small part of the $10 billion or so that could flee South Africa should its ratings all fall into junk.
Investors canvassed by Citi remain unperturbed by the fact the Russia OFZ federal bonds trade is crowded.
With OFZ returns of around 13 percent already this year in dollars, that confidence appears justified. But some policymakers and businessmen are becoming uneasy about rouble strength.
Inflows helped boost the rouble 8 percent this year - outgunning most emerging currencies despite oil's 4 percent fall.
Coming on top of a 20 percent appreciation in 2016, that has left the rouble overvalued by up to 12 percent, Siluanov complained recently.
Andrey Guryev, the chief executive of fertilizer company Phosagro (PHOR.MM) said the ruble's fair value was 63-65 per dollar and grumbled about the 9.75 percent interest rate.
"What we see clearly is that the Russian rouble is overpriced," Guryev told Reuters. "If I want to borrow in rubles it will be from 9-11 percent, which is ridiculous ... this is a really big problem, also for Russian GDP growth."
In fact, the ruble's real effective exchange rate -- against trade partners' currencies and adjusted for inflation -- is only slightly above its 10-year average
Meanwhile, Russian households and companies, lured by high deposit rates and a firm rouble, are joining in the bond rally. Individuals' dollar-denominated bank deposits comprised 23 percent of the total as of March 1, from 29 percent a year ago, central bank data shows. Russian lenders' rouble debt holdings rose to 65 percent up from 57 percent last March.
So might Moscow short-circuit the OFZ trade by engineering a rouble fall? It could do so through central bank interventions on top of the finance ministry's daily dollar purchases that were launched in February, or by speeding up rate cuts.
The ministry flavors a weaker rouble to boost budget revenues from energy exports.
But a sharply weaker currency would jeopardize the 4 percent inflation target. Central bank chief Elvira Nabiullina has said the rouble has not sharply deviated from justified levels and that she was not worried by the carry trade flows.
Chris Weafer, senior partner at Moscow's Macro-Advisory consultancy, called the dilemma "a delicate balancing act", predicting the currency will fall to 62 per dollar by year-end, with the possibility of bigger, 50 bps rate cuts.
But investors are not really banking on the rouble in this trade, says Lombard Odier's Ahmed.
Only a fifth of this year's total OFZ returns will come from rouble appreciation he reckons, versus half in 2016. The rest is down to falling bond yields -- 10-year yields fell this week to three-year lows of 7.86 percent, already down 64 bps from end-2016.
Additional reporting by Karin Strohecker Editing by Jeremy Gaunt