The word “default” – which became synonymous with “financial disaster” in Russia in 1998, when the country defaulted on its domestic debt – is again being heard with increasing frequency as Western financial sanctions against Russia make increasingly difficult for Moscow to service its international debt.

The prospect of a potential Russian default on sovereign Eurobonds looks alarming, but so far markets are barely reacting. Russian financial regulators assume that Russia has money, so they can trade as if nothing had happened. Much of the international reserves of the Ministry of Finance and the central bank were frozen at the end of February, but Russia was able to use these funds to make dollar payments until April 4 and use new income for payments until April 4. to May 25.

Around 72% of the Russia-2022 Eurobond was redeemed in rubles. Russia tried to pay the rest of the $2 billion obligation using dollars from frozen funds, and when it couldn’t, it used new revenue to make the payment in late April. However, at the end of May, he was unable to make the coupon payments.

The Ministry of Finance then announced a settlement scheme similar to that used for gas exports, but in reverse. Creditors were to open accounts in Russian banks (such as Gazprombank) and eventually receive euros and dollars: the assumption was that most creditors would not care what currency was used behind the scenes. But this scheme required the participation of Russia’s National Settlement Depository (NSD), and it seems untenable now that the NSD is also under European sanctions.

Nevertheless, the magnitude of the problem should not be overestimated. Russia has $18 billion in sovereign Eurobonds, of which about $1.2 billion is due in coupons per year (exact amounts depend on the dollar/euro exchange rate). About 70% of outstanding bonds are held by Russian investors, meaning they can be managed in rubles or in other ways that won’t lead to default. Another potential solution is a series of discounted early redemptions.

Of the remaining 30%, some bonds could be legally paid for in other currencies, leaving only around 10% of total Russian sovereign Eurobonds vulnerable to ‘true’ default (i.e. unable to default). be reimbursed), which is not a lot. Also, Russia has funds beyond the frozen assets, so the only real problem is that payments cannot be made directly. Russia also receives large inflows of foreign currency from exports, which it struggles to spend. So the government could take a page from an old playbook and arrange a discounted buyout facilitated by a friendly investor, or make payments using an unauthorized currency in a neutral jurisdiction such as the UAE, Turkey or Israel, or possibly Kazakhstan or Armenia.

The situation of ruble-denominated sovereign bonds – federal loan bonds (OFZ), which total around $40 billion according to the ruble/dollar exchange rate, with coupon payments of around 8%, or $3.2 billion dollars – is both simpler and more complex. Settlements are made in rubles and through special accounts, but sanctions against the NSD prevent payments through international depositories.

It would be quite easy for Russian financial regulators to unfreeze funds from institutions in friendly countries and allow them to acquire OFZs from non-residents of problematic jurisdictions, or reinvest the funds in new OFZs or government bonds. businesses. For example, when Russia began unfreezing the same type “C” accounts in 2000, funds from foreign investors that had been trapped in these accounts after the 1998 default were largely funneled into corporate bonds. Russians. There will be technical challenges in determining ownership of securities held outside of Russia, but these can be resolved, and the share of foreign investors who hold corporate and municipal ruble bonds is quite low.

The fate of corporate and bank Eurobonds – a segment worth around $90 billion – is more complicated. Some of these issuers have faced the toughest penalties: banks refuse to process their payments, financial institutions fail to service their obligations, and rating agencies no longer assign them ratings.

Yet here too there are mitigating factors. Requirements for issuers to maintain certain ratings are not as common today as they were in 2008, when Russia again faced a financial crisis, and demands for early debt repayment are less probable. Additionally, some companies have foreign assets, which could be separated from domestic assets and combined with foreign debts, although this may require additional clearances and payments to foreign bondholders.

Issuers that don’t have assets overseas or face tougher penalties could redeem their debts through neutral jurisdictions, possibly with the support of the Russian state. A surplus of foreign currency has made the ruble too strong, and buying bonds would be a good way to spend excess foreign currency and bolster the reputation of Russian issuers.

For many years, the Russian government has focused on keeping the national debt low. Russia has one of the lowest indicators among major countries, at only 17% of GDP compared to the three-digit figures of many developed countries and 160% for Russia itself in 1998. The national debt of Russia is also largely denominated in rubles.

Russia is prevented from borrowing when it really does not need to borrow. The situation is very different from late 2008, when low prices for most Russian exports triggered by the global credit crunch pushed major companies to the brink of default, and only a successful $35 billion bailout by the central bank and the Ministry of Finance saved them. There is even a difference from 2014, when declining export earnings coincided with the introduction of Western sanctions that Russia was not ready for, and foreign debt was around 40% higher than she is not now. The technical aspects of payments are currently the biggest problem for Russia, but this problem can be solved, even if it involves additional expenses or the involvement of intermediaries.

The new approaches will mean more work and more money for lawyers, bankers and intermediaries in neutral countries who might be willing to risk secondary penalties for potentially profitable transactions. The costs will be borne by investors and issuers, but even they will not lose everything unless they sell Russian assets when these bottom out.

As a result, Russia and Russian companies will have virtually no debt to investors from countries that have imposed sanctions, and the Russian financial market will be largely isolated from global finance. Over the next few years, especially if Russia’s key interest rate is lowered, its own resources should be sufficient to cover the needs of the budget, banks and businesses.

After that, the situation might get more difficult. If and when the sanctions against Russia are lifted and Russian issuers regain access to the capital markets, the history of sanctions will be calculated in the expected profitability of Russian securities. But other countries have returned to the market after multiple defaults.

A default by an issuer who still has funds is very different from a true default. As such, the market’s reaction to the uncertainty surrounding Russian stocks is mixed. However, even the prospect of large-scale sanctions imposition could exacerbate the balkanization of the global capital market and reduce the role of traditional financial instruments for the many developing countries that have their own political risks.

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