* Eurobond issue is first since sanctions
* Book still open, demand seen over $6bln
* Market sources say few big foreign investors
* Sanctions uncertainty put off some players
By Katya Golubkova, Lidia Kelly and Oksana Kobzeva
MOSCOW, May 24 (Reuters) - Russia was on track on Tuesday to place its first Eurobond since sanctions were imposed on it over the conflict in Ukraine, but market sources said it had so far failed to entice big Western investors to start buying Russian debt again.
The issue, the first in three years, was heavily subscribed by local investors who have been looking to offload surplus dollars. The funds raised will help the government, battered by a slowdown and sanctions, to fill gaps in the budget.
But the Eurobond was also designed to show that, despite sanctions and the standoff with the West over Ukraine, Russia could still tap into Western debt markets. On that count its success was unclear.
The book was still open with investors continuing to sign on, according to a financial source. Demand in the middle of the day on Tuesday stood at $6.3 billion, according to IFR, a Thomson Reuters news and financial service.
But several market sources told Reuters that there were few international players. They were dissuaded by warnings from Brussels and Washington that they risked running foul of sanctions.
“I don’t think it really shows very much in terms of Russia’s ability to get around sanctions,” said Timothy Ash, head of emerging markets strategy at Nomura.
“Rather the opposite, it shows still how logjammed Russia is and that it is still really dependent on local financing sources,” he said.
Russia last issued a Eurobond in 2013, a hiatus due in large part to the sanctions. They do not explicitly forbid anyone from handling Russian sovereign debt, but they create uncertainties and added risks for investors.
Analysts at Sberbank Investment Research said it was unlikely the share of foreign investors among buyers of the Eurobond would exceed 10-15 percent. Other market insiders see it in single digits.
“At the moment we are abstaining because of the lack of clarity around the liquidity, and compliance is making us careful,” said Rob Drijkoningen, global co-head of emerging markets debt at Neuberger Berman.
The dollar-denominated bond was eliciting strong demand because large local banks have a surfeit of foreign exchange liquidity amassed when the rouble went through a long weakening phase in 2014 and 2015.
There is limited demand for loans in foreign currencies because of risks the rouble will weaken further and tighter central bank restrictions. Local banks are therefore more interested in buying into the higher-yielding Eurobond than keeping cash on deposits.
The funds raised will help the finance ministry finance a budget deficit targeted at 3 percent of gross domestic product this year.
The deficit has been widening because of lower revenues caused by the slump in prices for oil, Russia’s main export, and higher spending to support the struggling economy.
“From the budget perspective, the placement is a positive factor because it allows the finance ministry to diversify funding sources,” Alexander Kudrin, an analyst at Sberbank Investment Research, wrote in a note.
Russia’s finance ministry had invited Western banks to organise the Eurobond issue, but none signed up.
Banking sector sources said there were thinly-veiled warnings behind the scenes from the U.S. government and Brussels that banks risked negative consequences if they took part in the issue.
Washington re-iterated its public message to companies contemplating doing business with Russia after the Eurobond issue was announced on Monday.
“We continue to be clear in our engagements with U.S. companies that we believe there are risks - both economic and reputational - associated with a return to business as usual with Russia,” said Mark Toner, a State Department spokesman.
Other, technical factors made it difficult for big foreign investors to buy the debt.
The world’s largest clearing banks, Euroclear and Clearstream, who act as intermediaries easing investment risks, are not involved and, according to the bond’s prospectus, there is “no assurance” they ever will.
The bond has been managed solo by VTB Capital, the investment banking unit of the state VTB Group which is itself under sanctions. The paying agent, in most cases a third party that takes payments from the issuer and distributes it to the bond holders, is the Russian finance ministry itself.
The bond’s prospectus said the proceeds will not go to companies subject to sanctions. But that failed to convince some investors.
“Do you believe them? Money at the end of the day is fungible,” said a London-based lawyer.
“If they raise money through a bond that in theory will free up other money which they can spend on things that are the target of sanctions.” (Additional reporting by Kira Zavyalova in MOSCOW, Arshad Mohammed in WASHINGTON, Sujata Rao-Coverley and Claire Milhench in LONDON; Writing by Lidia Kelly, editing by Christian Lowe and Jason Bush)