Analysis- War in Ukraine raises specter of Russia’s first external debt default By Reuters
© Reuters. FILE PHOTO: A Russian state flag flies above the headquarters of the Central Bank in Moscow, Russia March 29, 2021. REUTERS/Maxim Shemetov/File Photo
By Karin Strohecker
LONDON (Reuters) – With much of Moscow’s $640 billion in reserves locked up in the West and sanctions crippling cross-border capital flows, investors fear Russia is heading for its first-ever default on the sovereign debt in hard currencies.
On Wednesday, foreign investors were effectively stuck with their holdings of ruble-denominated bonds – known as OFZ – after the central bank temporarily halted coupon payments and the Euroclear settlement system stopped accepting coupons. Russian assets.
A default on ruble debt has precedent – Moscow reneged on OFZs during its 1998 financial crisis, but even then it maintained its dollar bond payments. Before the latest devastating Western sanctions that froze central bank assets, such a Russian default was not on anyone’s radar.
That’s partly because Russia, which calls its actions in Ukraine a “special operation”, has just $40 billion of international bonds outstanding across 15 dollar or euro-denominated issues, which is tiny compared to its peers and its own gross domestic product.
Bonds mostly traded well above par until mid-February, as investors ignored Moscow’s troop buildup on the Ukrainian border and the United States warned that an invasion was imminent.
Fast forward two weeks and bond investors have come to realize that default is no longer a distant prospect. Russia’s risk premium has soared and credit default swaps – derivatives used to secure exposure – are at record highs.
And some dollar bonds are now priced below 30 cents on the dollar, with abysmal trading volumes.
Foreigners, who own about half of Russia’s hard-currency debt, are focused on March 16, when it must pay $107 million in coupons on two bonds.
“Will Russia pay or not? There is a very significant uncertainty at this stage, after the sanctions applied to the Russian central bank and the Ministry of Finance,” said Marcelo Assalin, head of emerging market debt. at William Blair, investment manager and financial services company. London, which holds part of the Russian debt.
JPMorgan (NYSE:) and global banking lobby group the Institute of International Finance (IIF) have both warned that there is a significant increase in the risk that Russia is heading for its first default on its external debt.
March 16 is the first of several payments, with an additional $359 million due on a 2030 bond due March 31. The first principal payment is due on April 4 when a $2 billion bond matures.
In theory, Russia has sufficient reserves to cover its debt. In practice, the asset freeze has reduced what the central bank has available to make payments.
Second, payment execution will be trickier after sanctions limited Moscow’s access to global SWIFT payment systems. And finally, the asset freeze undermines Russia’s ability to defend its currency, increasing the cost of servicing external debt.
“The freeze in foreign exchange reserves could significantly weaken the ruble and raise fears of default for sovereigns and corporates alike,” said Dirk Willer, head of macro strategy, asset allocation and emerging markets at Citi in New York.
The central bank and finance ministry did not respond to a Reuters request for comment on the possibility of defaults.
Russia might still be able to pay, using available cash and even without SWIFT. But many argue he has little incentive to do so, given the West’s targeting of savings it had held overseas.
“The resolve of Western governments to cut Russia off from the international financial system, combined with a potentially weaker willingness on the part of the Russian government to repay its debt on time and in full, increases the likelihood of more severe credit outcomes for foreign holders of Russian Debt Securities,” rating agency Moody’s (NYSE:) said.
Moscow has already banned foreign investors from selling Russian domestic assets and ordered a temporary suspension of securities payments to foreign entities.
For Moody’s, this decision reflects “a growing lack of predictability in political decisions”
Moody’s downgraded its Baa3 credit rating for Russia on Friday. A few hours later, S&P Global (NYSE:) downgraded its equivalent Russian investment grade rating to “junk” and immediately put it on another downgrade warning.
The bonds themselves were issued with a mix of terms and deeds, JPMorgan notes. Notably, bonds sold after Russia was sanctioned for its 2014 annexation of Crimea contain a provision for payments in alternative currencies.
If “for reasons beyond its control” Russia has been unable to make payments or interest in the currencies in which the bonds were issued, in dollars and euros, payments can be made in dollars, euros, pounds sterling or Swiss francs, indicates the documentation.
Importantly, the ruble is listed as an alternative currency option for bonds issued since 2018, JPMorgan notes.
Since most Eurobonds have a 30-day grace period for principal and coupon payments, Morgan Stanley (NYSE:) calculates that the earliest possible default could be April 15, when the grace period expires on the 2023 bond coupon.
Meanwhile, default fears have also crept into the $35 billion market of Russian corporate debt. State-controlled Gazprom (MCX) is due to repay a $1.3 billion bond on March 7 – a litmus test of Moscow’s attitude toward foreign creditors.