EXPLAINER: The World Bank has warned Russia is “mighty close” to default on sovereign debt. It would mark the first country to suffer a major default in a century. Here are the implications for Russia and the world.
What is meant by a ‘Russian default’?
A sovereign debt default is when a country cannot or will not pay back its national debts, in what can be a major blow for future borrowing prospects.
Russia will have defaulted if it fails to make coupon payments due on its sovereign debt – bonds sold to investors, who lent Moscow money on the promise of steady repayments over an extended period.
Russia’s financial ministry has said it will pay bonds on time and in full, but has also floated the idea of making payments with roubles – a potentially controversial approach as the currency has plummeted, and it may simply not be allowed in the contract’s terms.
Has Russia defaulted before?
Russia has defaulted twice in recent history. The first was in the aftermath of the Bolshevik takeover in 1917, when revolutionaries refused to pay out tsarist bonds. The second was in 1998 when it restructured debts, and it defaulted only on domestic borrowing.
Will it default now?
Russia is due to pay out a US$117 million (NZ$170.74m) coupon on a Eurobond on Wednesday. If it fails, there is a 30-day grace period. The country will likely be deemed to have defaulted if a payment has not been made after then.
Russia has a sturdy balance sheet following years of conservative fiscal policy, but sanctions may mean it does not pay.
Wall Street’s top ratings agencies, which advise on the safety of investments, have already sounded the alarm: Fitch, Moody’s and S&P have cut the rating on Russia bonds to a low ‘junk’ grade, warning a default looks likely.
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Markets are bracing for Moscow to fail. Many traders are buying credit default swaps, insuring against the impact of borrower defaulting. Based on current pricing, markets predict a 71 per cent chance Russia will default in the next year, and 81 per cent for the coming decade.
Who would be affected?
Russia currently has US$39.7 billion of outstanding external debt – comparatively small compared to the US paying out almost US$140 billion on sovereign debt in 2020 alone. About half is held by foreigners. Another 3 trillion roubles of domestic debt was held by foreigners at the start of this year.
Most of that is held by financial institutions: banks, pension funds, asset managers and hedge funds.
Data from the Bank for International Settlements shows French banks held about US$4.5 billion of Russian government bonds as of last year, while US lenders held US$3.8 billion, Austria’s had US$3.2 billion and Italians US$2.6 billion. UK banks had just US$520 million of exposure.
A debt default is typically followed by a period of restructuring, when investors usually lose money. Moody’s estimates investors can expect to receive up to just two-thirds of the bond’s value. Some could respond with legal challenges.
What would it mean for Russia?
Recovering from a default can be a slow and arduous process, and may be even more complicated for Russia, given it is being squeezed out of the global financial system.
If Moscow tries to press ahead with making repayments in roubles, it could further devalue the currency, hammering home more inflationary pain for Russian consumers.
The reputational damage can also be heavy. Many investors are bound by covenants preventing them from investing in countries deemed to be in default. If it cannot sort out its debts, Russia may find there is limited interest next time it tries to borrow from international markets.
