Analysis: Russia’s ‘political’ debt default sets precedent in emerging markets

  • Russia says it paid $100 million in interest due May 27
  • The country was rated investment grade in early 2022
  • A default raises borrowing costs for issuers

NEW YORK/LONDON, May 27 (Reuters) – Russia is on the brink of a unique kind of debt crisis that investors say would be the first time a major emerging market economy has been pushed into a bond default. by geopolitics, instead of empty coffers.

Until the Kremlin launched an attack on Ukraine on February 24, few would have considered the possibility of Russia defaulting on its hard-currency bonds. Its strong credit history, excellent export earnings and an inflation-fighting central bank had made it a favorite of emerging-market investors.

But the US Treasury’s decision not to extend a license allowing Russia to keep debt payments despite sweeping sanctions has put Moscow on a path of default.

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Russia’s Finance Ministry transferred some $100 million in interest payments on two bonds due Friday to its national clearinghouse. But unless the money shows up in the accounts of foreign bondholders, it will constitute a default by some definitions.

And even if the funds dry up right now, payments of nearly $2 billion are due by the end of the year. One in late June is mandated to be resolved outside of Russia, a task experts predict will be impossible without the US waiver. Read More

Emerging-market debt crises are nothing new: Russia itself reneged on its ruble bonds in 1998. Geopolitics has spilled into the debt sphere before, too, forcing defaults on Venezuela and Iran, for example.

However, in the case of Iran, small amounts of credit debt were affected by US sanctions after its 1979 revolution, while Venezuela’s economy was already on its knees before the US restrictions. The US in 2019 will push $60 billion in sovereign and sub-sovereign debt to the brink.

Meanwhile, Russia continues to rack up oil and metal profits. Even with half of its $640bn reserve war funds frozen by sanctions, the central bank has enough cash to pay off the outstanding $40bn in hard-currency sovereign debt.

“This is a completely different crisis than other emerging market crises, it’s not about the ability or the willingness to pay, technically they can’t pay,” said Flavio Carpenzano, chief investment officer at Capital Group, an asset manager that, like many others, was exposed to Russia before the war broke out. read more

The shock is amplified by the fact that this would be Russia’s first major foreign bond default since shortly after its 1917 Bolshevik revolution. The sanctions on Russia and its own countermeasures have effectively cut it off from global financial systems.

Comparisons with recent defaults, such as Argentina in 2020, are inappropriate because most countries’ finances are strained when defaults occur, said Stephane Monier, chief investment officer at Lombard Odier.

“This would be the first externally and politically driven default in emerging market history,” Monier said.

The expiration of the Treasury license means creditors may not be able to receive payments anyway, which Daniel Moreno, head of global emerging markets debt at Mirabaud Asset Management, likened to “turning the world upside down.”

“I, the creditor, am now not willing to accept payment,” he added.

THERE IS NO WAY BACK

Russia’s international bonds, most of which started the year trading above par, have lost value between 13 and 26 cents on the dollar. They have also been kicked out of the indices.

One key difference from previous defaulters like Argentina or Venezuela is that Russia’s attack on Ukraine, which it calls a special operation, has made it a pariah in the eyes of many investors, likely for years to come.

“There is a huge stigma attached to owning these bonds as emerging market asset managers are under pressure from their clients asking them not to invest in Russia and liquidate their positions,” said Gabriele Foa, portfolio manager. Algebris Global Credit Opportunity Fund.

For now, a potential default is symbolic because Russia can’t borrow internationally anyway, nor does it need to. But what comes later is crucial.

Regime change in Russia could at some point end Western sanctions and allow it to return to the fold.

But first, creditors face a lengthy and costly process to recover the money, for example by exchanging defaulted bonds for new ones. read more

A default stigma would also increase future borrowing costs.

Defaulting “increases the cost of financing and this is very likely to happen to Russia as well. They will have to pay a premium,” Capital Group’s Carpenzano said.

The White House expects a default to have minimal impact on the US or global economy, but Carpenzano acknowledges that developments around Russia are forcing a re-evaluation of geopolitical risks in emerging markets. read more

“Geopolitical noise has increased and investors would like to be compensated for this increased risk,” he said, citing strong investment outflows from China in recent weeks.

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Reporting by Davide Barbuscia in New York and Sujata Rao, Karin Strohecker, Marc Jones and Jorgelina do Rosario in London Editing by Susan Fenton

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