Lending markets

What a Russian default would mean for financial markets as the invasion of Ukraine continues

The threat of a Russian sovereign debt default is near, but investors are not panicking so far over a potential hit to global financial markets.

“While a default is symbolic, it seems unlikely to have significant ramifications, both in Russia and elsewhere,” William Jackson, chief emerging markets economist at Capital Economics, said in a Monday note. .

Talk of a Russian default, however, brings back memories of past troubles. In August 1998, Russia devalued the rouble, defaulted on its domestic debt, and declared a moratorium on payment to foreign creditors. The resulting crisis shook the financial markets, causing the collapse and subsequent bailout of the Long Term Capital Management hedge fund.

International Monetary Fund Managing Director Kristalina Georgieva said on Sunday that Western sanctions in response to the country’s invasion of Ukraine on February 24 would hit Russia hard, reducing real incomes and purchasing power. Russians. She warned that a Russian default can no longer be considered an “unlikely event”.

Georgieva, in an interview with CBS News’ Face the Nation, noted that while Russia has the money to pay off its debt, sweeping sanctions against the country’s financial institutions and central bank mean it can’t go any further. to access. Rating agencies have downgraded Russia’s debt sharply, with Fitch warning last week of impending default due to sanctions.

But Georgieva said that while foreign exposure to the Russian banking sector at $120 billion was not negligible, it was “certainly not systemically relevant”.

Moscow is expected to make about $117 million in combined interest payments on two dollar-denominated bonds on Wednesday, according to reports. Russia’s finance ministry said on Monday it was ready to make the payments, but could do so in rubles if it doesn’t have access to the issuing currency, according to Reuters. Reports noted that no bonds allow payments in another currency.

Failure to pay in dollars could cause Russia to technically default after a 30-day grace period, analysts said.

The highest potential cost to Russia of a default is being shut out of global financial markets, or at least facing higher borrowing costs for an extended period, Jackson said, but noted that “the sanctions did it anyway”.

For foreign investors, “a default is largely priced in,” the economist wrote, noting that Russia’s dollar sovereign bonds are already trading at around 20 cents on the dollar (see chart below).

Capital saving


News reports also suggest creditors have already pared their holdings, he said. And to Georgieva’s assertion that Russian debt is not systemically relevant, Jackson noted that the overall size of Russian foreign currency sovereign debt held by nonresidents is “relatively small,” at around $20 billion. of dollars.

“Even if the government stops payments to foreign investors on all their sovereign debt holdings (local and foreign), the total of around $70 [billion] is no bigger than the debt Argentina defaulted on in 2020 without causing a jolt in global markets (although in Argentina’s case bond prices didn’t fall that far) said Jackson.

Stock markets were volatile following the invasion, but the threat of default was not flagged as a major source of concern for investors. US stocks rose sharply on Tuesday, with the Dow Jones Industrial Average DJIA,
+1.82%
up almost 600 points, or 1.8%, while the S&P 500 SPX,
+2.14%
advanced by 2.1%.

So nothing to see here? Not enough.

Jackson pointed out two risks.

First, there is the possibility that beneath the aggregate numbers, a systemically important institution is heavily exposed to Russian sovereign debt and potentially capable of sending jolts through the financial system.

Second, a sovereign default could be a prelude to defaults by Russian companies, he warned, whose external debts are far larger than those of the government (see chart below).

Capital saving


“So far, Russian companies appear to have continued to service their debts since the tightening of sanctions. But with trade disrupted, sanctions potentially expanded and the economy poised for a deep recession, the likelihood of corporate defaults increases,” Jackson said.