Russia has avoided its first default since 1918, but it is not out of the woods yet

Russia appears to have escaped what could have been its first default on foreign currency since 1918. 

It ordered payment of $117m in interest payments on two dollar denominated bonds on Wednesday, despite widespread speculation that it wouldn’t be able to do so. Earlier this week, Russia maintained that it would pay back debts in roubles, rather than dollars – something that would have almost certainly been classified as a default. 

Russia has come under a barrage of sanctions in recent weeks, cutting it off from roughly $640bn of foreign reserves, which would make it much harder for it to repay its debt.

So is Russia out of the woods? 

Russia’s finance ministry said it made the payments to Citigroup in London, but it remains uncertain whether investors will receive the money, says the Financial Times.  Under US sanctions, investors can still receive interest payments from Russia until 25 May. 

The ministry said it was waiting to find out whether the payment had been accepted by Citi or not. If Wednesday’s payment is not accepted, then Russia has a 30-day grace period before it officially defaults on its foreign currency debt.

And the Wall Street Journal points out that Russia still has another $615m in payments to make by the end of March, and a further $2.1bn is due in April, so Russia is still not out of the woods. 

And Fitch said earlier this week that failure by Russia to pay debt on OFZ bonds, due on 2 March would result in default if it was not “cured” within 30 days. 

OFZ bonds, which are local currency bonds, are federal loan bonds issued by Russia’s government.  The country’s Ministry of Finance auctions them  to fund the federal budget or to bail out troubled banks.  So, OFZ plays a crucial role in Russia’s financial system.

How much foreign debt does Russia have?

At just under $60bn, Russia’s foreign currency debts are considered minuscule compared to some other countries. This is partly because Russia has been under some form of sanctions since it invaded Crimea back in 2014. 

As the Wall Street Journal puts it, “Russia has been fairly restrained in raising money in recent years, partly out of prudence and partly because of previous rounds of sanctions.”

Because of this, the last time Russia issued dollar-denominated bonds was back in 2019. 

Last week, credit ratings agency Fitch downgraded Russia’s once investment grade credit rating to junk. Russian bonds are trading at around 20% of their face value. 

What would it mean for the economy?

Russia’s payment on Wednesday means the likelihood of a default has fallen. But, if it does still happen, while certainly an unpleasant market event, it is unlikely to reverberate too harshly across the world. 

Many foreign investors had already trimmed their exposure to Russia. 

Before the invasion, Russian sovereign debt represented around 6% of JPMorgan’s emerging market bond index. But on 7 March, JPMorgan said it would remove Russian sovereign and corporate debt from its indices. 

Blackrock – the world’s biggest asset manager – is estimated to have had the most exposure to Russian dollar debt, with approximately worth $1.5bn of holdings. 

A default makes restructuring agreements between debtors and creditors extremely difficult given the sanctions that are currently in place. 

So a Russian default risks investors having to weather the losses until a deal can be brokered with the Kremlin. But that is a while away. 

Another point of reassurance according to the Wall Street Journal is that not all Russian companies are struggling with payments. “Despite the rhetoric, some Russian companies, such as Gazprom, have made on-time payments on their foreign debt in US dollars, so it’s not clear what the Russian government will decide to do.”

Has Russia defaulted before?

Russia’s last debt crisis of 1998, when it defaulted on local currency bonds, shook Wall Street. 

Long Term Capital Management (LTCM), a hedge fund, held a significant position in Russian government bonds and had to be bailed out to the tune of $3.6bn by a number of Wall Street banks organised by the Fed. LTCM entered into liquidation two years later.