About the Author: David Beers is a senior fellow at the Center for Financial Stability, a New York-based think tank. He led S&P Global’s sovereign rating team between 2005 and 2011, then worked as a special advisor at the Bank of Canada and the Bank of England. His views expressed in this essay do not necessarily reflect those of his current and past employers.
Since the beginning of Russia’s invasion of Ukraine in February 2022, there has been intense debate in financial markets and the media – and quite a bit of confusion – about a possible default by Russia on its sovereign debt. This raises important questions about the current state of the Russian Federation’s obligations, the mechanisms of default and, if there is one, its repercussions. I will focus on Russian bonds denominated in foreign currencies, but keep in mind that the federal government has other forms of sovereign debt as well.
Last month, the International Monetary Fund forecast Russia’s “general public debt” – the broadest measure of public debt, which combines federal, regional and local government obligations – at around $306.8 billion. in 2022. That’s little changed from its estimate of $302. billion in 2021. It should be noted that Russia’s public debt is low, at around 17% of GDP, compared to the public debt of most sovereign states in advanced economies and emerging markets.
Less than a third of Russia’s sovereign debt is denominated in foreign currency and the rest is in Russian rubles. US dollar and euro bonds, with a face value of around $40 billion, are the largest component and have attracted the most market scrutiny. According to Bloomberg and Morgan Stanley, about $4.7 billion in interest and principal on these bonds is due this year.
But Russia has not yet defaulted on its debt. About $731 million in scheduled debt service was due in March, at a time when global sanctions on Russia froze a significant portion of its foreign exchange reserves held outside the country. This, in turn, increased market uncertainty about Russia’s ability to pay. Initially, Russia threatened to repay its debt in rubles, including on bonds that did not allow this option. Despite the sanctions, however, so far Russia has been able to pay the foreign currency debt service owed on its obligations within the contractual grace periods.
Why didn’t Western sanctions prevent Russia from repaying these debts? The answer to this question is not entirely clear. American and European authorities are certainly able to prevent Western banks from transferring the money to repay foreign bondholders. However, they seem to have concluded that, at least for now, allowing such payments will further erode Russia’s liquid foreign exchange reserves.
It wouldn’t be the first time that Russia has defaulted. More recently, it defaulted in 1998, a few years after the collapse of the Soviet Union. This default impacted about $78 billion in obligations to public and private creditors, including nearly $30 billion in foreign currency obligations and $36 billion in ruble debt. It took nearly a decade for most of these obligations to be settled. Russia’s default was triggered, in part, by financial contagion from the Asian financial crisis, which began in 1997 (but ironically had little lasting impact on US bond investors). nascent emerging markets).
The war with Ukraine this year has significantly affected Russia’s credit ratings. Sovereign ratings by credit rating agencies assess the willingness and ability of governments to repay their obligations on time and in full. The Russian Federation received its first ratings from market leaders Moody’s, S&P Global and Fitch in the late 1990s. Until recently, all three rated Russia in the BBB investment grade. The ratings were then heavily reduced after Russia invaded Ukraine, and the agencies withdrew them in March and April this year, possibly because of Western sanctions. Before doing so, S&P declared Russia’s attempt to pay debt service owed on one of its US dollar ruble bonds a default. But, as already mentioned, this appeal was premature.
Will Russia continue to service its foreign bond debt? Probably not for very long. The war turns out to be longer than initially expected by the Russian regime. At the same time, the scale of Western economic and military aid given to Ukraine and sanctions imposed on Russia in response has been greater than expected. As the conflict drags on, the incentives for Russia to continue repaying its foreign debt are likely to fade. Before the end of the year, I would not be surprised if Putin’s regime defaulted on most of its foreign obligations and used them as bargaining chips in any future settlement of the Ukrainian conflict. The resolution of this default, in turn, will likely take at least as long as the 1998 default. But given Russia’s diminishing economic and financial influence, its impact on global financial stability should be manageable.
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