payment default is imminent
Is Russia heading for bankruptcy again?
03/09/2022 11:42 am
In view of the sanctions imposed by the West, it is more than uncertain whether Russia will repay its debts abroad. International investors have to be prepared for payment defaults.
Western sanctions imposed in the wake of the Ukraine war have all but taken Russia off the international financial markets. But what is supposed to increase the pressure on President Vladimir Putin and make the Kremlin give in by isolating the Russian economy has unpleasant side effects for investors. Experts see Russia’s debt service in acute danger. After 1998, there could be another state bankruptcy – even if a lot is different this time. Despite a full state coffers, Russia is threatened with insolvency.
The President of the Berlin DIW Institute, Marcel Fratzscher, considers a national debt bankruptcy in Russia to be very likely in the coming months. Because of the Western sanctions, there is a high risk that Russia will not service its debts to international creditors, Fratzscher told the DPA. Some German investors would also suffer from a default. In addition, there could be distortions on the financial markets. The Russian central bank is already trying to cushion the economic impact of western sanctions on the financial market with a number of measures. The central bank also imposed drastic restrictions on foreign exchange trading on Wednesday night.
According to the financial news service Bloomberg, Russia has 49 billion dollars in government bonds outstanding in dollars and euros. More than $100 million in interest payments are due on March 16. A $2 billion bond issue is due to expire on April 4th. “We see default as the most likely scenario,” US investment bank Morgan Stanley wrote to clients. “I would be shocked – absolutely shocked – if they bother to make their payments later this month,” ex-hedge fund manager Jay Newman said in a recent Bloomberg interview.
Even the major rating agencies give investors little hope. Fitch, Moody’s and S&P now see Russia’s creditworthiness in the so-called junk zone, which is intended to indicate high-risk investments. Fitch warned on Tuesday of an imminent default. S&P cut its credit rating eight notches on Friday, to just above the default category. At Moody’s, the rating fell to even lower junk levels due to “serious concerns about Russia’s willingness and ability to service its debt.” That brings back memories.
Parallels to the situation in 1998?
Flashback: August 17, 1998 marks the blackest day in the economic history of the new Russia. At that time, the government stopped servicing the domestic debt due to tight budgets and released the ruble for devaluation. The financial markets tumbled. Trust in Russia was gone. After years of stability, the ruble lost 75 percent in just a few weeks. Russian banks could no longer meet their obligations. International financial organizations stopped providing support.
This time the situation differs in important respects. The starting position is completely different. At that time, Russia had high national debt and low foreign exchange reserves. In addition, the ruble was still pegged to the dollar, so the central bank had to defend the exchange rate. In the wake of the Asian crisis and falling oil prices, this turned out to be hopeless. Today, Russia’s treasury is bulging – not least thanks to high oil and gas prices. But the sanctions have frozen much of Russia’s central bank reserves of around $640 billion.
The credit watchdogs at S&P and Moody’s also emphasize that the main reasons for the increased risk of non-payment are not money shortages, but the consequences of the sanctions. They also severely limit the central bank’s options. Even if Russia were to pay, it would therefore be uncertain whether creditors abroad would get their money. Another problem for international investors: credit default insurance may not apply to some bonds. Because Russia could settle debts in rubles, but should not transfer the money abroad.
No protection for creditors
Either way, a tricky situation is emerging. Expert Newman studied the prospectuses of Russian bonds and came across some of “the craziest things I’ve ever seen”. Unlike standard government debt, most bonds did not contain a clause waiving government immunity in the event of default, leaving it unclear how and where the government could be taken to court. “There is absolutely no protection for creditors with all these bonds.”
Newman knows what he’s talking about. He worked for years for the NML Capital hedge fund, which specializes in cannibalizing bad loans, from the Elliott empire of US billionaire Paul Singer. Newman also played an important role in the 15-year legal dispute over the repayment of Argentina’s bond debt from the approximately $100 billion state bankruptcy at the end of 2001. NML ultimately collected the debt. With an army of lawyers, the hedge fund hunted down state property abroad and even had a naval frigate in Ghana confiscated in 2012. But Newman wants nothing to do with Putin’s papers: “I wouldn’t pay a penny for these bonds.”
Even if the bond payments were not made in the coming week, this would not mean that Russia would default overnight. After the first non-payment, a 30-day grace period usually begins, so the actual default would not occur until April. In addition, due to the exceptional situation caused by the sanctions, it could initially only be a question of a technical or partial default, i.e. not yet a state insolvency in the strict sense.