What impact would a Russian debt default have on global markets?

Credit rating agencies say Russia is on the verge of defaulting on government bonds after invasion Ukraine, with billions of dollars owed to foreigners. This prospect is reminiscent of a 1998 Moscow default that helped fuel financial disruption around the world.

The possibility of default increased after International Monetary Fund Managing Director Kristalina Georgieva recently admitted that a default by Russia is no longer an “unlikely event.”

Why do people say that Russia is likely to default?

On Wednesday, Russia faces a $ 117 million interest payment on two dollar-denominated bonds.

Western sanctions stemming from the Ukrainian war have imposed severe restrictions on banks and their financial transactions with Russia, and have also frozen much of the government’s foreign exchange reserves. Finance Minister Anton Siluanov said the government had issued instructions to pay the coupons in dollars, but added that if the banks could not do so due to the sanctions, the payment would be made in rubles. There is a grace period of 30 days before Russia is officially in default.

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So Russia has the money to pay, but says it can’t because of sanctions that have restricted banks and frozen much of its foreign exchange reserves. However, the measure is also in line with efforts to restrict the outflow of foreign exchange reserves that have become scarcer due to sanctions.

Rating agencies have downgraded Russia’s credit rating below the investment grade, or “junk”. Fitch said his “C” rating means “a default or similar process has begun.”

Russia can pay in rubles?

Some of Russia’s bonds allow payment in rubles under certain circumstances. But these links do not. And there are indications that the amount of the ruble would be determined by the current exchange rate, which has plummeted, which means that investors would get much less money.

Fitch said Wednesday that paying in local currency for the bonds in question “would constitute a sovereign default when the 30-day grace period expires.”

Russia would also be in arrears on payments to foreigners on ruble-denominated bonds that would expire on March 2 after a similar 30-day grace period. These payments were made to a state deposit fund, but were not sent to foreign investors due to restrictions by the Russian central bank.

“This will be a default if it is not corrected within 30 days of the due date,” the rating agency said.

In addition, “If coupon payments are not made in U.S. dollars on the original terms, at the end of the grace period,” Russia’s credit rating would be further downgraded to a ‘D’]according to Fitch.

Even for dollar bonds that allow payments in rubles, things could get complicated.

“The rubles are obviously useless, but they are rapidly depreciating,” said Clay Lowery, executive vice president of the association of financial institutions at the International Institute of Finance. “My guess is that it could be a legal issue: are they extraordinary circumstances or were they caused by the Russian government itself because the Russian government invaded Ukraine? That could be fought in the courts.”

How do you know if a country is in default?

Rating agencies may lower the default rating or a court may decide the issue.

Bondholders who have credit swaps (derivatives that act as non-payment insurance policies) can ask a “determination committee” of representatives of financial companies to decide whether a default should lead to a default. payment, which is not yet a formal declaration of non-payment.

It can be complex. “There will be a lot of lawyers involved,” Lowery of the IIF said.

What wider impact could a Russian default have?

Most investment analysts believe that a default by Russia would not have the kind of impact on global financial markets and institutions than in 1998. At the time, Russia’s default on ruble bonds added to a crisis. finance in Asia.

The US government had to intervene and get banks to rescue Long Term Capital Management, a large US hedge fund whose collapse was feared could have further threatened the stability of the financial and banking system. wide.

This time, however, “it’s hard to say before 100%, because every sovereign default is different and the overall effects would only be seen once it’s over,” said Daniel Lenz, head of euro rate strategy at DK Bank. in Frankfurt. , Germany. “That said, a breach by Russia would no longer be a big surprise to the market as a whole … If there were big shockwaves, you would see it. That doesn’t mean there won’t be any major problems in smaller sectors. “.

The impact outside of Russia could be reduced because foreign investors and companies have reduced or avoided business there since a previous round of sanctions imposed in 2014 by the US and the European Union in response to Russia’s unrecognized annexation of the Crimean peninsula of Ukraine.

IMF Director Georgieva said that while the war has devastating consequences for human suffering and a far-reaching economic impact in terms of rising energy and food prices, a breach of if only it would be “definitely not systematically relevant” in terms of risks to the surrounding banks. the world.

Bondholders, for example, funds that invest in emerging market bonds, could suffer serious losses. Moody’s current rating implies that creditors would suffer losses of 35% to 65% on their investment if there is a default.

What happens when a country defaults?

Investors and the delinquent government will often negotiate an agreement in which bondholders receive new bonds that are worth less but at least provide them with partial compensation. It is difficult, however, to see what might be the case now with the ongoing war and Western sanctions that prevent many deals with Russia, its banks and companies.

In some cases, creditors may sue. In this case, it is believed that Russian bonds include clauses that allow most creditors to reach an agreement and then force that agreement on the rest, avoiding the demands of minority creditors.

Once a country defaults, bond market debt can be cut until default is resolved and investors regain confidence in the government’s ability and willingness to pay. The Russian government can still borrow rubles at home, where it depends mainly on Russian banks to buy their bonds.

Russia is already suffering a severe economic impact from sanctions, which have dropped the ruble and disrupted trade and financial ties with the rest of the world.

Therefore, the defect would be another symptom of Moscow’s broader political and financial isolation as a result of its invasion of Ukraine.

Russian entities could too choose default, forcing foreign lenders to take on debt losses “as a form of retaliation against Western sanctions,” William Jackson, chief economist of emerging markets at Capital Economics, said in a research report.

The Russian government could also ban foreign debt payments, Jackson said.