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

  • Russia says it paid $100 million in interest due May 27
  • The country is rated investment grade in early 2022
  • Defaults push up borrowing costs for issuers

NEW YORK/LONDON, May 27 (Reuters) – Russia is on the cusp of a unique debt crisis that investors say will be the first time a major emerging market economy has fallen into bond default due to geopolitics rather than short positions.

Before the Kremlin’s February 24 attack on Ukraine, few thought that Russia might default on its hard currency bonds. Its strong solvency record, strong export earnings and inflation-fighting central bank make it a favorite among emerging market investors.

But the U.S. Treasury Department’s decision not to extend a license that allows Russia to continue to pay its debt despite widespread sanctions has put Moscow on a path to default.

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Russia’s finance ministry has remitted about $100 million in interest on two bonds due Friday to its domestic settlement agency. But unless the money is in the accounts of foreign bondholders, it would constitute a default by some definitions.

Even if the funding goes through this period, nearly $2 billion will be disbursed by the end of the year. One mission in late June was to settle outside Russia — a task experts predict would have been impossible without a U.S. waiver.read more

Debt crises in emerging markets are nothing new—Russia itself turned its back on rouble bonds in 1998. Geopolitics has also spilled over into the debt space before, such as forcing Venezuela and Iran into default.

In the case of Iran, however, U.S. sanctions after the 1979 revolution hit a small amount of loan debt, while Venezuela’s economy was struggling before U.S. restrictions pushed $60 billion of sovereign and subsovereign debt to the edge in 2019.

Meanwhile, Russia continues to profit from oil and metals gains. Even with half of its $640 billion reserves frozen due to sanctions, the central bank still has enough cash to service $40 billion in sovereign hard currency debt.

“This is a crisis that is completely different from other emerging market crises, it’s not about ability or willingness to pay, they’re not technically able to pay,” said Flavio Capenzano, investment director at Capital Group, an asset management firm The company, like many others, was affected by pre-war Russia.read more

The impact is amplified by the fact that it will be Russia’s first major foreign bond default since the Bolshevik Revolution in 1917. Sanctions on Russia and their countermeasures effectively insulate it from the global financial system.

Stephane Monier, chief investment officer at Lombard Odier, said it would be inappropriate to compare recent defaults such as Argentina’s in 2020, as most countries’ finances were strained at the time of default.

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

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

“I, the creditor, are now reluctant to accept payment,” he added.

no way back

Russia’s international bonds, most of which traded above par at the start of the year, have fallen to between 13-26 cents per dollar. They are also culled from the index.

A key difference from past defaulters such as Argentina or Venezuela is that Russia’s attack on Ukraine — which it calls an extraordinary operation — has made it an outcast in the eyes of many investors, likely for years to come.

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

For now, a potential default is symbolic because Russia cannot borrow internationally anyway, nor does it need to. But what comes next is crucial.

Regime change in Russia may at some point end Western sanctions and bring it back.

But first, creditors face a lengthy and expensive process of getting their money back, such as exchanging defaulted bonds for new ones.read more

Default stigma also increases future borrowing costs.

Capital Group’s Carpenzano said a default “would increase the cost of financing, and that’s likely to happen in Russia. They need to pay a premium.”

The White House expects the default to have minimal impact on the U.S. or global economy, but Capenzano believes events around Russia are forcing a reassessment of geopolitical risk in emerging markets.read more

“There has been an increase in geopolitical noise, and investors want to be compensated for this higher risk,” he said, citing a surge in investment outflows from China in recent weeks.

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Davide Barbuscia in New York and Susan Fenton, reporting editor in London with Sujata Rao, Karin Strohecker, Marc Jones and Jorgelina do Rosario in London

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