Russian Debt Default ‘Priced-In’ by Investors But Risks Remain, ‘Butterfly Effect’ Could Impact Multiple Entities

An exterior view shows Russia's Central Bank headquarters in Moscow, on March 29, 2021. (Maxim Shemetov/Reuters)

Russia’s attack on Ukraine and the resulting international sanctions have triggered fears of a potential debt default by Moscow, something which economist William Jackson says is unlikely.

A Russian default will likely be “symbolic” and not have any significant consequences within Russia or elsewhere, Jackson, the chief emerging markets economist at Capital Economics, said in a note.

A potential Russian default has largely been “priced in” by foreign investors. Nonresidents only hold around $20 billion in Russian foreign currency sovereign debt, which he considers “relatively small.”

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

However, the economist foresees two risks. The first is the possibility of a systematically critical institution getting significantly exposed to Russian sovereign debt. If this entity gets affected, it could cause “broader financial contagion.”

Secondly, a sovereign default might just be a prelude to corporate defaults. External debts of Russian corporates are larger than that of the government. With Russia’s trade disrupted due to sanctions, and the economy slipping into a likely recession, the chances of businesses defaulting are increasing.

Earlier, Kristalina Georgieva, managing director of the International Monetary Fund (IMF), had stated that a Russian default can no longer be seen as an “improbable event.” But even though the country’s banking sector has a foreign exposure to the tune of $120 billion, Georgieva doesn’t consider it to be “systematically relevant.”

Some experts are of the opposite view and believe a Russian default might turn out to be rather catastrophic.

Since Russia’s debt was rated investment grade only a few weeks ago, these securities are held in various benchmarks and fixed-income portfolios. As such, the impact of a Russian default can send tremors across endowments, pension funds, foundations, and more, that invest in such securities.

“This will be a monumental default,” said Jonathan Prin, a portfolio manager at Greylock Capital Associates, as cited by Bloomberg. “In dollar terms, it will be the most impactful emerging-market default since Argentina’s. In terms of broader market impact, it’s probably the most broadly felt emerging-market default since Russia itself in 1998.”

Back in August 1998, Russia devalued its currency and defaulted on some of its ruble-denominated debt, stunning global markets. LTCM, a popular hedge fund at the time, got badly hit and had to be bailed out by the Fed. The dollar fell over 10 percent against the yen in October that year within a period of two days.

Willem Buiter, an external member of the Bank of England’s Monetary Policy Committee at that time, notes that though there are differences between the 1998 situation and the current one, there can still be casualties in case Russia ends up defaulting on its sovereign debt.

“We always have the butterfly effect. The bad news is, we don’t know a lot about the web of direct and indirect exposures of financial and non-financial entities to asset and commodity markets that are in so much turmoil right now,” he said to Reuters.

Russia is due to pay roughly $117 million as interest payments on two dollar-denominated bonds on March 16.

Though Moscow had announced that it is in a position to make the payment, it admitted that the payment might have to be done in rubles if sanctions prevent Russian banks from honoring debts in the currency of issue. Both bonds reportedly do not allow for making payments in currencies other than the U.S. dollar.