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Russia's Struggle To Meet Sovereign Debt Obligations

Default looms.

Photo by Haseesh Rahithya on Unsplash
Moscow City Skyline by Haseesh Rahithya on Unsplash

A bit of history first. In the Russian Revolution of 1917, the Bolsheviks, led by Vladimir Lenin, ended the Tsarist rule. Russia then had one of the world's biggest foreign debts. And the Bolsheviks refused to honor Tsarist debt, which shocked global debt markets. Tsarist notes were worth nothing, and some used them as wallpaper.

Fast forward to 2014. Western sanctions, imposed following the annexation of Crimea, taught Russia a lesson. It slashed its sovereign debt from $700 billion to $500 billion. It has also built the world's fourth-largest foreign reserves cache of $640 billion. Russia's debt load is roughly 18% of GDP. For comparison, it is 102% for the United States.

Sanctions Squeezing

The economic sanctions by the West have cut off the Russian central bank's ability to access half of its foreign-currency reserves. However, Russia still can access its foreign reserves not covered by Western sanctions. The non-Western reserves include currencies like the Chinese yuan and assets like gold. Chinese yuan makes up about 13% of Russia's total reserves. Beijing is not participating in sanctions against Russia. The Kremlin has announced that as long as sanctions remain, it will use rubles to repay its debt, even if it is in foreign currency.

The face value of Russia's international bonds is around $40 billion outstanding. International investors hold roughly half. Russia's corporates have amassed far more foreign debt.

In terms of payment, bonds sold after the 2014 Crimea annexation allow alternative currency payments in dollars, euros, British pounds, or Swiss francs. The ruble is an option currency for bonds issued since 2018.

Russian bonds were trading above par well into February. They are now distressed, worth a tenth of their face value. The price of Russian government bonds maturing in 2047 fell by more than half in a single day, while the yield skyrocketed to 18% from 8% at the end of last week.

Coupons Due

Today, $117 million in interest payments on two dollar-denominated bonds are due. Russia has to make the payments in U.S. dollars and has a 30-day grace period. Even if Russia wants to pay back in rubles, it will trigger a default. Another $615 million is due for the rest of March. On April 4, $2 billion will reach maturity.

Downgraded To Junk Status

Moody's cut Russia's credit rating this month to its second-lowest tier. Fitch downgraded Russian bonds to a "C" grade from 'B' considering an imminent default.

Last week, the World Bank's chief economist, Carmen Reinhart, cautioned that Russia and ally Belarus were "mightily close" to defaulting on debt repayments.

On Sunday, the managing director of the International Monetary Fund, Kristalina Georgieva, said that Russian sovereign debt default is no longer an "improbable event." She added, "We have to see what is the prospect for allowing service of debt obligation…because in this case, it's not that Russian doesn't have money. Russia cannot use this money."According to her, banks have $120 billion in Russian exposure. A default could still cause significant pain to financial institutions with Russia's exposure.

Credit Default Swaps

Credit default swaps (CDS) are insurance policies purchased by investors to protect their investments in situations like this. Pacific Investment Management Co. (Pimco) has $1.1 billion in credit default swaps, obligating Pimco to compensate other bondholders if Russia defaults. According to JPMorgan, it has approximately $6 billion in CDS obligations.

Russian Default

If Russia defaults, it will affect its credit rating and the ability to borrow in the future. It will have to pay a higher interest rate to borrow money and fund projects. It can drive up interest rates in the country and hamper economic growth. It takes years to earn back good ratings. For example, Argentina took 15 years to regain access to international investors after its default in 2001.

It is clear that Russia's invasion of Ukraine will impact its economic and financial future. How the Russian economy will survive and how much Russians will have to endure remains to be seen.

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