There is no doubt that the war in Ukraine has savaged the Russian economy. Not only is spending for the military operation higher than had been anticipated, but the sanctions imposed by the west are biting hard, including on Russians’ cost of living. Amid the economic uncertainty, the question is now being asked whether Moscow might default on its debt.
The context is one of economic instability. Soon on after the invasion the rouble lost some 40 per cent of its value, despite intervention from the Russian central bank. That intervention became much more difficult when half of the $630bn-worth of Russian foreign currency reserves, including those denominated in US dollars and euros, were frozen by the west. Inflation had already shot up to just under 10 per cent pre-invasion, and the central bank reacted by raising interest rates to 20 per cent to contain any further surge. It seems to have done the trick. The rouble has partly recovered, though it is still some 5 per cent below where it was pre-invasion. Russia’s latest threat to ask for payment in roubles from next week for oil, gas and most of its other exports, including grain, would—one assumes—be aimed at further strengthening the currency.
The abrupt interest rate hike and currency volatility show the rapidly changing fortunes of the Russian economy. Earlier forecasts predicted growth of some 2.4 per cent this year. These have been sharply downgraded, with Standard and Poor’s, for example, now expecting a drop of 8.5 per cent. The European Bank for Reconstruction and Development expects a 10 per cent fall. Foreign companies closing their operations and pulling their investments will not help. Much will depend on the continued flow of oil and gas revenues into Russia, which for the moment attract high prices. But the US’s immediate ban of Russian oil imports, and moves by the UK and the EU to wean themselves off energy dependency on Russia, will also impact on growth prospects, even if Moscow succeeds in diverting exports elsewhere.
Early in the conflict, the rating agencies downgraded Russian bonds, with Fitch indicating that a default was imminent. If that happened, it would be the first Russian default since 1998—though that one was on domestically held debt. The issue here is on debt owed to foreign bondholders. It isn’t large in global terms, estimated at just $45bn. But it remains a worry for those holding it, mainly institutional investors and banks.
The first test came on 16th March, when Russia had to pay interest of some $117m on its bonds. The speculation was that it would insist on paying in roubles, if it paid at all. That of course would have contravened the bond contract and possibly triggered a technical default. But in the end, Russia seems to have paid it all—and in foreign currency—although it is not clear whether it was allowed to use some of its frozen foreign exchange assets to do so. It also paid another $102m coupon due on a sovereign bond that matures in 2035. Since then, domestic trading in Russian bonds has restarted after a three-week break and bond yields have been coming down. Crisis seems to have been averted for now.
But there are bigger problems round the corner. A large repayment of a $2.2bn Eurobond at maturity is due on 4th April. And in just the last day or so, the Russians have announced their intention to do a buy-back of the Eurobond in roubles at current exchange rates—taking advantage, presumably, of the recovery of the rouble but also, one assumes, to pay back local holders of the bond. That has once again worried the markets, as it could backfire and hasten a technical default, especially as many exchanges no longer accept the rouble as a settlement currency.
Would that matter much for Russia? Yes, if it then found it difficult to re-enter the capital markets once hostilities are over, assuming an “acceptable” postwar settlement is reached. It would also cause an immediate headache for the many Russian companies which have been operating in the west and which have a lot of debt denominated in foreign currency themselves. Many of them, like Gazprom, are either partly owned by the Russian state or have very close links with it, and their credit rating will be affected. It would cause a headache too for the many western financial institutions that have been lending to those firms. As creditors they will have difficulty, given the current environment, in accessing or selling any of those firms’ assets. The prospect therefore of a default—not just on sovereign debt but also some $100bn of private external debt—will be much harder to bear. Expect a compromise.
