© Reuters. FILE PHOTO: A view of Russian ruble coins in this illustrative photo taken on March 25, 2021. Photo: Maxim Shemetov/Reuters
Written by David Barbuscia and Sujata Rao
NEW YORK/LONDON (Reuters) – Russia is on the cusp of a unique kind of debt crisis that investors say will be the first time a major emerging market has defaulted on bonds due to geopolitics rather than empty coffers.
Until the Kremlin launched its attack on Ukraine on February 24, few had considered the possibility of Russia defaulting on its hard-currency bonds. Its strong solvency track record, record export earnings, and a central bank that fights inflation have made it a preferred destination for emerging market investors.
But the US Treasury’s decision not to renew the license that allows Russia to continue paying the debt despite sweeping sanctions has put Moscow on the path to default.
The Russian Treasury transferred about $100 million in interest payments to the Local Settlement House on Friday’s bonds. But unless the money appears in the accounts of foreign bondholders, some tariffs constitute a default.
And even if the money passes during this time, nearly $2 billion is due to be repaid by the end of the year. One is scheduled to be launched in late June outside of Russia – a task experts predict would be impossible without the US concession.
Debt crises in emerging markets are nothing new – Russia itself abandoned its ruble bonds in 1998. Geopolitics has also had an impact on the debt sphere before, forcing Venezuela and Iran into bankruptcy, for example.
But in the case of Iran, small credit debt was hit by US sanctions after the 1979 revolution, while Venezuela’s economy was already on its knees before US restrictions released $60 billion in government and quasi-government debt in 2019.
Meanwhile, Russia continues to collect oil and mineral revenues. Even with sanctions freezing half of its $640 billion war fund, the central bank still has enough cash to repay the $40 billion in hard-currency sovereign debt.
“This is a very different crisis from other emerging market crises, it’s not about the ability to repay or willingness to pay, they technically can’t pay,” said Flavio Carpenzano, investment director at Capital Group, an asset manager who – like many others – said: – I faced Russia before the outbreak of the war.
The effect is compounded by the fact that this would be Russia’s first major default on foreign bonds since shortly after the Bolshevik Revolution of 1917. Sanctions and countermeasures against Russia effectively isolated it from the global financial systems.
Stephane Meunier, chief investment officer at Lombard Odier, said comparisons with recent defaults such as Argentina in 2020 are inappropriate because most countries’ finances are tight on defaults.
“This will be the first externally and politically motivated default in the history of emerging markets,” Mounir said.
The expiration of the Treasury’s license means that creditors may not be able to receive payments anyway, which Daniel Moreno, head of global emerging market debt at Mirabud Asset Management, likened to “turning the world upside down.”
“I am the creditor, I am not ready to accept payment now,” he added.
Russia’s international bonds, most of which were trading above par earlier in the year, fell to between 13 and 26 cents on the dollar. They were also kicked out of the indicators.
The main difference from previous defaulters like Argentina or Venezuela is that Russia’s attack on Ukraine – which it calls a special operation – has made it a pariah in the eyes of many investors for years to come.
“There is a lot of stigma to actually owning these bonds as emerging market money managers are under pressure from their clients telling them not to invest in Russia and liquidate their positions,” said Gabriel Foa, portfolio manager at Algebris Global Credit Opportunity Fund.
For now, the potential default is symbolic because Russia cannot and does not have to take any international loans anyway. What matters is what comes next.
Regime change in Russia may eventually end Western sanctions and leave them in the fold.
But first, creditors face a long and costly process of getting money back, such as replacing bad bonds with new ones.
The default stigma will also increase future borrowing costs.
By defaulting, “the cost of financing increases, and it is very likely that Russia will do the same. You have to pay a premium,” said Karpizano of the Capital Group.
The White House expects defaults to have little impact on the United States or the global economy, but Carpenzano believes events in Russia will force a reassessment of geopolitical risks in emerging markets.
“The geopolitical noise has increased and investors want to be compensated for this higher risk,” he said, citing huge investment flows to China in recent weeks.