Russia on the verge of default: this Wednesday is $117 million due in interest that it has no way to pay

Russia is on the verge of default. On Wednesday, the country has to pay about USD 117.2 million in interest maturities and, although it ordered its correspondent bank to comply with that obligation, it is possible that the sanctions imposed on it will prevent the money from reaching the bondholders. The one that Russian President Vladimir Putin would suffer would be the first Russian default since 1998 and the first default in foreign currency denominated debt since 1918, when the revolution repudiated the financial obligations incurred in previous years.

Russia has something to pay with and, as far as is known, it intends to do so. But as Russia's $640 billion in foreign exchange reserves are largely frozen after the invasion of Ukraine, it may not be able to make part of the payments. Those that are supposed to materialize in US currency.

Yesterday morning, the Russian Ministry of Finance announced that it approved a temporary procedure for the repayment of foreign exchange debts, but that rubles will be used if necessary.

Finance Minister Anton Siluanov said in a statement that “claims that Russia cannot meet its sovereign debt obligations are false.”

“We have the necessary funds to meet our obligations,” he added, saying that Russia has to pay its Eurobonds coupons on March 16 and has already given the order to Western banks to carry out the operation.

“If we see complications in the execution of the order, on Tuesday we will prepare a relevant transfer order in the equivalent in rubles,” Siluanov said in a television interview quoted by Reuters.

Several Russian banks were excluded from the international payments network SWIFT, making efforts to move money out of Russia more difficult.

Siluanov also suggested that Russia will use its yuan reserves to settle its foreign exchange needs, but that could also be counted as a default. If not paid, Russia will have a grace period of 30 days before formally falling into default.

Western governments even fear that China will assist in payments, in a firm show of support that may further complicate global tension, which in itself reached unimaginable levels a few weeks ago.

The Chinese currency accounted for 13.1% of the Russian central bank's foreign exchange reserves in June 2021, up from only 0.1% in June 2017, and Moscow dollar holdings fell to 16.4% from 46.3% in the same period.

China is Russia's main export market after the European Union. Russian exports to China were worth $79.3 billion in 2021, of which oil and gas accounted for 56%, according to the Chinese customs agency.

Although some Russian bonds denominated in foreign currency — those issued after 2018 — allow payments in rubles if they cannot be made in other currencies (such as dollars, euros, Swiss francs or pounds sterling), that does not apply to payments this Wednesday.

The managing director of the International Monetary Fund, Kristalina Georgieva, said on Sunday that sanctions imposed by Western governments on Russia in response to its invasion of Ukraine would provoke a sharp recession this year. He added that the IMF no longer sees default on Russian sovereign debt as an “unlikely event.”

His warning followed that of the World Bank's chief economist Carmen Reinhart, who warned last week that Russia and its ally Belarus were “very close” to defaulting on debt payments.

However, despite the high risk of default, the IMF's Georgieva told CBS that a broader financial crisis in the event of Russian default was unlikely for now, considering that world banks' $120 billion exposure to Russia “is not systematically relevant.”

The credit rating agency Fitch last week downgraded the Russian sovereign debt rating to “C”, stating that “sovereign default is imminent.”

For its part, S&P Global Ratings also downgraded Russia's sovereign foreign and local currency credit ratings to “CCC-” on the grounds that Moscow's measures to mitigate the barrage of unprecedented sanctions imposed by the United States and its allies “will likely substantially increase the risk of non-payment.”

Moody's also cut Russia's credit rating earlier this month to its second lowest level, citing the same central bank capital controls that could make foreign currency payments difficult, leading to defaults.

Economists from Deutsche Bank pointed out that the 30 days of grace before formalizing default may be key.

“Thirty days still allow time for a negotiated end to the war, and therefore it is probably not yet the time when we see where all the tensions in the financial system could lie,” said Jim Reid, global head of credit strategy at Deutsche Bank, in an email quoted by CNBC.

The Russian default, if it materializes, can be purely symbolic. For example, the one in Argentina in 2020 did not cause major problems for the global financial system and was even bigger than the one feared for this week.

The Russian government did not go into much debt, in preparation for a war. JPMorgan estimates that it had about $40 billion in foreign currency debt at the end of last year, about half of which was held by foreign investors.

But the possible consequences of a default are difficult to gauge. The global financial crisis of 2008 and the coronavirus pandemic demonstrated how negative shocks can spread across the modern, interconnected financial system and global economy.

International banks hold credits of more than USD 121 billion from Russian entities, according to the Bank for International Settlements (BIS). European banks have more than $84 billion in total credits, with France, Italy and Austria being the most exposed, while US banks owe $14.7 billion.

Even if Moscow suspends payments to foreign investors of all sovereign debt, the default of some $60 billion — including ruble debt held abroad — would be on the same level as Argentina's in 2020, an event of no importance for the markets. On the other hand, the total size of Russian sovereign foreign currency debt held by non-residents is relatively small, about 20 billion dollars.

But an analysis by Capital Economics that coincides with optimism about the absence of dangerous global effects pointed out that there is a major financial institution - which it does not name - especially exposed to Russian debt, which could lead to wider financial contagion. On the other hand, a second risk is that a default could trigger default on the part of Russian companies.

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