NEW YORK (BLOOMBERG) - Russia’s economy is fraying, its currency has collapsed and its debt is junk. Next up is a potential default that could cost investors billions and shut the country out of most funding markets.
Warning lights are flashing as the government kick-starts the process of paying US$117 million (S$160 million) in interest on US dollar bonds on Wednesday (March 16), a key moment for debt holders who have already seen the value of their investments plunge since Russia invaded Ukraine last month.
The government says that all debt will be serviced, though it will happen in roubles as long as sanctions - imposed because of the war - do not allow US dollar settlements. Failure to pay, or paying in local currency instead of US dollars, would start the clock ticking on a potential wave of defaults on about US$150 billion (S$205 billion) in foreign currency debt owed by both the government and Russian companies, including Gazprom, Lukoil and Sberbank.
Such an event will revive memories of previous crises, including Russia in 1998, when it defaulted on some rouble-denominated debt, and Argentina three years later.
Signs of looming financial damage are becoming apparent at many of the world’s biggest money managers, including BlackRock and Pacific Investment Management. But it is not likely to be limited to these giant funds. As much of Russia’s debt was rated investment grade just weeks ago, the securities were pervasive across global fixed income portfolios and benchmarks, meaning the impact could ripple across pension funds, endowments and foundations.
“This will be a monumental default,” said Mr Jonathan Prin, a portfolio manager at Greylock Capital Associates. “In dollar terms, it will be the most impactful emerging market default since Argentina’s. In terms of broader market impact, it’s probably the most broadly felt emerging market default since Russia itself in 1998.”
Russia is already a commercial pariah, crippled by sanctions and the exodus of foreign firms such as Coca-Cola and Volkswagen since the war started. The government has responded with capital controls, restricting outflows of money to protect the economy and the rouble.
Businesses and households are facing a double-digit economic slump and inflation accelerating towards 20 per cent. About half of the country’s foreign exchange reserves - some US$300 billion - have been frozen, according to the finance minister.
Regardless of the Kremlin’s policy on foreign debt payments, companies will find it harder to service their obligations as falling demand hits sales and profits.
Due to the sanctions and various decrees Russia introduced in response, a default appears all but inevitable. Swap markets put about a 70 per cent chance on it happening this year. Fitch Ratings said it is “imminent”. Indicative pricing on the country’s bonds values some of them near 20 cents on the dollar. Just days before the invasion, those same notes traded above par.
In addition to bonds crumbling to distressed levels, the conflict has left its mark on multiple markets. The rouble has plunged about 35 per cent against the dollar this year, and local stock trading has been shut for two weeks.
Russia’s late 1990s default was on domestic debt, so a foreign currency default would be the first since the aftermath of the 1917 revolution, when the Bolsheviks refused to recognise the czar’s debts.
On Monday, Russia’s Finance Ministry issued an order to pay the US$117 million, although it did not specify the currency. Using roubles is not an option for this week’s coupons, based on the terms of those bonds.
If Russia does not meet its obligations, there is technically a 30-day grace period that gives it until April 15 to make good.
About US$120 billion of the current outstanding government and company debt is denominated in US dollars, with the bulk of the remainder in euros, according to data compiled by Bloomberg. Roughly US$25 billion was issued by Gazprom, the state-owned natural gas giant.
While the debt is substantial, it is probably not enough to cause a systemic problem for financial markets. That is the view of International Monetary Fund managing director Kristalina Georgieva, who said last weekend that banks’ exposure is “not systemically relevant”.
A handful of the sovereign eurobonds do have contractual language allowing payments in local currency, and some companies issued their debt via foreign subsidiaries and have dollars offshore. Yet there is still huge uncertainty, especially as clearing houses including Clearstream and Euroclear have stopped accepting the rouble as a settlement currency and have barred Russian entities from most transactions.
As for Russian companies, even before a single one misses a payment on its obligations, another challenge is emerging: finding lawyers and advisers willing to take their business. Last week, JPMorgan Chase declined to advise search engine Yandex on a potential debt restructuring.
In the meantime, multiple deadlines are looming. Steel and mining company Severstal has a coupon due on Wednesday, and both Evraz and Tinkoff Bank have interest payments due on Sunday. Gazprom has payments next week, with issuers including oil refiner Sibur and gold mining company Polyus to follow.