Russia is approaching debt default and reserves rubles for bondholders

Russia is closer to a possible default on its debt on Wednesday, as it set aside rubles to pay holders of international bonds that must be paid in dollars and said it would continue to do so as long as its foreign reserves are blocked by sanctions.

The United States on Monday prevented Russia from paying its sovereign debt holders more than $600 million of frozen reserves in US banks, and said Moscow had to choose between depleting its dollar reserves at home or not paying.

Russia has not stopped paying its foreign debt since it defaulted on payments due after the Bolshevik revolution of 1917, but its bonds have resurfaced as a high point in the diplomatic crisis and sanctions between Moscow and the Western powers.

“This accelerates the timeline when Russia runs out of space in terms of willingness and ability to pay,” said a fund manager who had one of the bonds that needed to be paid.

The Kremlin said it would continue to pay its dues.

“Russia has all the resources necessary to pay its debts... If this blockade continues and payments intended to pay debts are blocked, (future payment) could be made in rubles,” said Kremlin spokesman Dmitry Peskov.

Moscow managed to make a series of currency coupon payments on some of its 15 international bonds with a face value of around $40 billion in circulation before the United States stopped such transactions.

While sanctions have frozen roughly half of $640 billion in Russia's gold and foreign currency reserves, the country still receives billions of dollars from oil and gas exports.

The Russian Finance Ministry said on Wednesday that it had to pay rubles to holders of its dollar-denominated Eurobonds due in 2022 and 2042, as a foreign bank refused to process a $649 million payment order to its sovereign debt holders.

The Ministry of Finance said that the foreign bank, which it did not appoint, rejected Russia's order to pay the coupons for the two bonds and also did not process the payment of a Eurobond due in 2022.

Russia's ability to meet its debt obligations is in the spotlight after sanctions in response to the invasion of Ukraine froze nearly half of its reserves and limited access to global payment systems.

The United States targeted Russian banks and elites on Wednesday with a new round of sanctions.

The US Treasury prevented JP Morgan, which had been processing Russian sovereign bond payments as a correspondent bank, from making the two payments due on Monday, a source familiar with the situation said.

Russia may consider allowing foreign holders of its 2022 and 2042 Eurobonds to convert ruble payments into foreign currencies once access to their foreign currency accounts is restored, the Finance Ministry said.

Until then, the ruble equivalent of Eurobond payments addressed to bondholders of so-called hostile nations will be held in special 'C' type accounts in the Russian National Settlement Deposit, the ministry added.

Both bonds were issued in 2012 and stipulate payment in US dollars, unlike some bonds that were later sold and allow payment in alternative currencies such as the euro, the pound sterling, the Swiss franc or even the ruble.

Russia has a 30-day grace period to make the payment in dollars, but if cash does not appear in the bondholders' account within that period, it would constitute a default, global rating agencies said.

Moscow introduced strict capital controls to prop up its currency after the war, which, in combination with financial sanctions, makes it impossible for foreign investors to repatriate any payments.

One-year advance credit default swaps, a way to ensure exposure to Russia's sovereign debt, rose from 60 to 69 points, according to IHS Markit.

Russia's longer-term dollar bonds, where trading has almost ceased, traded well below 20 cents on the dollar, while euro-denominated issues were offered at 15 cents.

Bondholders had been tracking bond payments since Moscow's radical sanctions and countermeasures that separated Russia from the global financial system.

A default by Russia would have been unthinkable before the invasion, as the country still had an investment-grade rating in February from the top rating agencies.

Russia is already excluded from international lending markets due to Western sanctions, but a default would mean that it would not be able to regain access until creditors have received full payment and legal cases arising from the default are resolved.

A default could also create a number of headaches if countries or companies that would normally trade with Russia have self-imposed rules that prohibit transactions with a defaulting entity.

In addition, Russian debt default insurance policies known as credit default swaps (CDS) contracted by investors for such situations could be activated. JP Morgan estimates that there are approximately $6 billion worth of CDS in circulation that should be paid.

Russia paid coupons on four OFZ treasury bonds in rubles on Wednesday. These were once popular for their high returns among foreign investors, who are now unable to receive payments as a result of Russian sanctions and reprisals.

(With information from Reuters)

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