What a Russian debt default would mean for financial markets as the invasion of Ukraine continues

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What a Russian debt default would mean for financial markets as the invasion of Ukraine continues

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The threat of a Russian sovereign debt default is near, but investors do not panic so far over any potential hit on global financial markets.

“While a default would be symbolic, it seems unlikely it will have any significant ramifications, both in Russia and elsewhere,” William Jackson, chief emerging market economist at Capital Economics, said in a statement on Monday.

Speaking of Russian default, however, stirs memories of past turmoil. In August 1998, Russia devalued the ruble, defaulted on domestic debt and declared a moratorium on payments to foreign creditors. The resulting crisis shook the financial markets, causing the collapse and subsequent bailout of the Long Term Capital Market hedge fund.

International Monetary Fund CEO Kristalina Georgieva on Sunday declared Western sanctions in response to the country’s February 20. The invasion of Ukraine would hit Russia hard, reducing Russian real incomes and purchasing power. You warned that a Russian default can no longer be considered an “unlikely event”.

Georgieva, in an interview with CBS News’s Face the Nation, noted that while Russia has the money to honor its debt, sweeping sanctions against the nation’s financial institutions and central bank mean it can no longer access it. Rating firms heavily downgraded Russian debt, with Fitch last week warning of an impending default due to sanctions.

But Georgieva said that while the $ 120 billion foreign exposure to the Russian banking sector was not negligible, “it certainly wasn’t systemically relevant.”

Moscow is expected to make about $ 117 million in combined interest payments on two dollar-denominated bonds on Wednesday, according to the news. The Russian finance ministry on Monday said it was ready to make payments, but could do so in rubles if it is unable to access the issuing currency, according to Reuters. Reports found that neither bond allows payments in another currency.

Failure to pay in dollars could see Russia in technical default after a 30-day grace period, analysts said.

The biggest potential cost to Russia from a default is being locked out of global capital markets, or at least facing higher financing costs over an extended period, Jackson said, but noted that “the sanctions have done so anyway. “.

For foreign investors, “default is largely a foregone conclusion,” wrote the economist, noting that Russia’s dollar government bonds are already trading at around 20 cents per dollar (see chart below).

Economy of capital

The news also suggests that creditors have already reduced their holdings, he said. And on Georgieva’s claim that Russian debt is not systematically relevant, Jackson noted that the overall size of Russian foreign currency sovereign debt held by non-residents is “relatively small,” around $ 20 billion.

“Even though the government stops payments to foreign investors on all of their (local and foreign) sovereign debt holdings, the total of about $ 70 [billion] it’s no bigger than the debt Argentina defaulted on in 2020 without causing tremors in global markets (although in Argentina’s case, bond prices haven’t dropped that much), “Jackson said.

Equity markets were volatile in the wake of the invasion, but the threat of a default was not reported as a major concern for investors. US stocks were mostly down on Monday, extending the previous week’s decline. The Dow Jones Industrial Average DJIA,
+ 0.00%
increased by 1 point, or less than 0.1%, while the large-cap benchmark S&P 500 SPX,
-0.74%
it was down by 0.7%.

So nothing to see here? Not exactly.

Jackson pointed to two risks.

First, there is the possibility that under the aggregate numbers, a systemically important institution is heavily exposed to Russian sovereign debt and is potentially capable of sending tremors through the financial system.

Second, a sovereign default could be a prelude to the insolvencies of Russian companies, he warned, whose foreign debts are much larger than those of the government (see chart below).

Economy of capital

“So far, Russian companies appear to have continued to pay their debts since the sanctions were tightened. But with the disruption of trade, potentially expanded sanctions, and the economy poised for a deep recession, the likelihood of corporate insolvencies is on the rise, “Jackson said.

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