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The implications of Russia’s impending default

  • Russia’s government appears to be heading towards a default on its foreign currency debts for the first time since the Bolshevik revolution. This won’t affect the Russian government’s ability to finance itself (beyond what sanctions have already done) and it seems unlikely that there will be significant spillovers elsewhere. Perhaps the bigger risk is that it may be a prelude to defaults by Russian corporates, whose external debts are more than four times larger than those of the sovereign.
  • In a note published two weeks ago, we warned that default risks in Russia had risen sharply. This week is likely to see perhaps the most tangible evidence that things are moving in that direction, with the Russian government scheduled to make a coupon payment on Eurobonds on Wednesday equal to around $117mn.
  • The government has warned that payments to creditors from ‘hostile’ countries will be made in rubles. Although some Russian FX bonds (those issued from 2018) allow payments in rubles if they can’t be made in other currencies (dollars, euros, Swiss francs or sterling), that doesn’t apply to the upcoming payments.
  • While we’re not experts on the legal matters, that would presumably be a breach of the contract and tantamount to default (after a 30 day grace period). That, in turn, would mark the first sovereign default by Russia since 1998 (when it defaulted on domestic debt) and the first sovereign default on foreign currency debt since Lenin repudiated the government’s obligations in 1918.
  • While a default would be symbolic, it seems unlikely that it will have significant ramifications, both in Russia and elsewhere. For Russia, the main cost is being locked out of global capital markets, or at least higher borrowing costs for a prolonged period. But sanctions have done that anyway. The relatively strong public finances mean that the government is not dependent on foreign investors for financing. (We’ll be looking at the outlook for Russia’s public finances in more detail in a forthcoming Update.)
  • For foreign investors, a default is largely priced in. Russia’s sovereign dollar bonds are already trading at 20 cents on the dollar. (See Chart 1.) And media reports suggest that creditors have already marked down their holdings. Moreover, the overall size of Russian foreign currency sovereign debt held by non-residents is relatively small, at around $20bn. (See Chart 2.)
  • Even if the government halts payments to foreign investors on all their holdings of sovereign debt (local and foreign), the total of around $70bn is no larger than the debt Argentina defaulted on in 2020 without causing tremors in global markets (although in Argentina’s case, bond prices didn’t fall quite as far).
  • That said, there are two risks. First, underneath the aggregate numbers, one systemically institution might be particularly exposed to Russian sovereign debt, which could cause broader financial contagion. And second, a sovereign default could be a prelude to defaults by Russia’s corporates – whose external debts are much larger than those of the government. (See Chart 2 again.)
  • So far, Russian corporates seem to have continued servicing their debts since sanctions were tightened. But with trade disrupted, sanctions potentially being widened and the economy set for a deep recession, the likelihood of corporate defaults is rising. (For more, see our Emerging Europe Update that takes a detailed look at Russian corporate debt and our Global Economics Update on financial exposures to Russia.)

Chart 1: Russia Sovereign Dollar Bond Prices

Chart 2: Russia External Debt (Sep. 2021, $bn)

chart001-183.pngchart002-137.png

Source: Refinitiv

Sources: CBR, Capital Economics


William Jackson, Chief Emerging Markets Economist, william.jackson@capitaleconomics.com