Russia’s first external default in a century now looks all but inevitable after another brutal week for the country’s finances.
First, the Treasury halted dollar debt payments from Russia’s accounts in U.S. banks, ramping up its restrictions on the country. Then, when an attempted hard-currency payment was blocked, Russia breached the terms on two bonds by paying investors rubles instead of dollars.
That pushed the countdown clock a step closer to default. It’s been ticking since Russia invaded Ukraine in February, and the U.S. and others swiped back with a clampdown on banks, companies and oligarchs. A freeze on the central bank’s foreign reserves unplugged Russia from the global financial system, making it the world’s most-sanctioned nation in a matter of days.
With Vladimir Putin’s government hampered by asset blocks and branded a pariah by Western countries — politically, economically and financially — speculation has mounted that Russia would only be able to avoid a default for so long. The country’s bonds are already trading deep in distressed territory, and insurance on the debt now suggests almost a 90% chance that a default will happen this year, according to the latest figures from ICE Data Services.
Russia last defaulted in 1998, but on domestic debt. The last one on foreign debt was in the aftermath of the 1917 revolution. S&P said Saturday that it had declared Russia in a selective default after it used rubles to make a payment on a dollar-denominated bond on April 4.
There’s still uncertainty about what’s next and further twists can’t be ruled out.
The dollar bonds that were serviced in rubles this week have 30-day grace periods, giving Finance Minister Anton Siluanov time to find a workaround or push his argument that this isn’t a default because a payment was technically made. This week he said the rubles transferred in lieu of dollars can be converted for creditors just as soon as the reserves freeze is eased.
“Western countries are trying in every possible way to make Russia declare default,” Siluanov told state news service Tass this week. He also said Russia will use “other mechanisms” to make payments.
In the meantime, the financial world waits for an official judgment on whether a default event has occurred.
But where that decision comes from is unclear. After a string of cuts that pushed Russia deep into junk, ratings firms are abandoning coverage because of an EU ban on providing ratings to the country. Moody’s Investors Service and Fitch Ratings have already withdrawn, S&P Global said in its statement Saturday that it will respect the April 15 EU ban and all its ratings on Russia were subsequently withdrawn.
There’s also the Credit Derivatives Determinations Committee of buy-side and sell-side firms that vote on whether a credit event has taken place and whether default swaps have been triggered. The committee is already reviewing a question on the possible default of the state-owned railway operator, which failed to pay bond interest on time in March.
“If Russia does not manage to organize a payment route to bondholders within the grace period and no dollars arrive into the accounts, then it is a default, the CDS will trigger,” said Lutz Roehmeyer, chief investment officer at Berlin-based Capitulum Asset Management.
Ever since the Feb. 24 invasion and the sweeping sanctions that followed, Russian debtors have struggled to get funds to creditors on time. Banks’ compliance departments pored over the payments with extra checks. Initially, the disruption was felt most in the corporate sector, and multiple businesses have failed to make bond payments on time. This week, Sovcombank PJSC became the first bank to say it will miss a payment on foreign-currency bonds.
Then, the U.S. Treasury threw up a major hurdle for the sovereign by blocking access to bank accounts, effectively torpedoing a Treasury sanctions carve-out that had allowed bond payments to go ahead from Russia’s overseas accounts, despite the central bank reserve freeze.
The decision to block that route to payment came after reports of Russian atrocities in the Ukrainian town of Bucha over the weekend.
The move was designed to force Russia to tap into domestic sources of funding or hard-currency earnings from oil and gas exports, thus sapping the cash available for the government to further an invasion that’s destroyed cities, killed thousands, and displaced 11 million people.
The bond market drama is playing out against a warped economic backdrop. On the one hand, the economy is sliding into deep recession. On the other, capital controls have underpinned an extraordinary rebound in the ruble that allowed the central bank to slash rates by 300 basis points this week in a surprise move.
Even as Western nations race to reduce their reliance on Russian commodities, the country is still raking in billions of dollars from exports of oil and gas, keeping it flush with cash for now.
Given those inflows, the government says it has the funds to pay creditors. It’s blamed payment issues on the central-bank asset freeze and the swirling uncertainly that accompanied it.
According to Tim Ash, an emerging-markets strategist at Bluebay Asset Management, there will be no quick fix for Russia because sanctions are set to stay and no one will want to do business there.
“Putin has crossed the rubicon with his actions in Ukraine,” he said. “Russia will be in default for perhaps a decade. That means no access to international capital markets, very high costs of borrowing even from the Chinese, no investment, no growth, low living standards. It’s a terrible outlook for Russia and Russians.”
