EXPLAINER: What would a Russian bond default mean?

Rating agencies say Russia is set to default on government bonds after its invasion of Ukraine, with billions of dollars owed to foreigners. That prospect brings back memories of a Moscow default in 1998 that helped fuel financial turmoil around the world.

The possibility has become more than just market speculation after International Monetary Fund chief Kristalina Georgieva admitted that a Russian default is no longer an “unlikely event”.

An overview of the possible consequences of a Russian default:

WHY DO PEOPLE SAY RUSSIA IS LIKELY TO DEFAULT?

On Wednesday, Russia faces a $117 million interest payment on two dollar-denominated bonds. Western sanctions from the war in Ukraine have placed severe restrictions on banks and their financial dealings with Russia. Finance Minister Anton Siluanov said the government had given instructions to pay the coupons in dollars, but added that if banks could not do so due to sanctions, payment would be made in rubles. There is a 30-day grace period before Russia is officially in default.

So Russia has the money to pay but says it can’t because of sanctions that have restricted banks and frozen much of its foreign currency reserves. Rating agencies downgraded Russia’s credit rating to below investment grade, or junk. Fitch rates Russia “C”, which means, according to Fitch, “sovereign default is imminent”.

WHAT DO THE SMALL FEATURES SAY?

Some of Russia’s bonds allow payment in rubles under certain circumstances. But these links do not. And the indications are that the amount of the ruble would be determined by the current exchange rate, which has plunged, meaning that investors would receive much less money.

Even for bonds that allow payments in rubles, things could be complicated. “Rubles are obviously not worthless, but they are depreciating rapidly,” said Clay Lowery, executive vice president of the association of financial institutions at the International Institute of Finance. “I guess it could be a legal issue: are these extraordinary circumstances or were they caused by the Russian government itself because the Russian government invaded Ukraine? It could be argued in court .

Rating agency Moody’s says that “all other things being equal” paying in rubles on bonds that don’t allow it would be “a default by our definition.” “However, we would need to understand the facts and circumstances of particular transactions before making a default decision,” he said.

HOW MUCH OWS RUSSIA?

Russia as a whole has about $491 billion in foreign debt, including $80 billion due over the next 12 months, according to Algebris Investments. Of this amount, $20.5 billion is in dollar-denominated bonds held by nonresidents.

HOW TO KNOW IF A COUNTRY IS IN DEFAULT?

Rating agencies can lower the rating for default, or a court can decide the matter. Bondholders who have credit default swaps – derivatives that act as insurance policies against default – can ask a “determination committee” made up of representatives of financial firms to decide whether a payment must trigger a payment, which is still not a formal declaration of default.

It can be complex. “There will be a lot of lawyers involved,” Lowery of the IIR said.

WHAT WOULD BE THE IMPACT OF A DEFAULT BY RUSSIA?

Financial analysts cautiously believe that a Russian default would not have the kind of impact on global financial markets and institutions that the 1998 default had. At the time, Russia’s default on ruble bonds added to a financial crisis in Asia. The US government had to step in and get the banks to bail out Long-Term Capital Management, a large US hedge fund whose collapse, it was feared, could have threatened the stability of the wider financial and banking system.

This time, however, “it’s hard to say 100% in advance, because every sovereign default is different and the global effects would only be visible once it happened,” said Daniel Lenz, Head of Euro Rates Strategy at DK Bank in Frankfurt. , Germany. “Having said that, a Russian default would no longer be a big surprise to the whole market. … If there were to be big shock waves, you would already see it. This does not mean that there will not be significant problems in the small sectors.”

The impact outside Russia may be muted because investors and foreign companies have reduced or avoided transactions there since a previous round of sanctions imposed in 2014 by the United States and European Union in response to Russia’s unrecognized annexation of Ukraine’s Crimean peninsula. IMF chief Georgieva said that although the war had devastating consequences in terms of human suffering and had far-reaching economic impact in terms of rising energy and food prices, a flaw in itself would be “definitely not systemically relevant” in terms of risks for banks around the world.

Bondholders – for example, funds that invest in emerging market bonds – could suffer heavy losses. Moody’s current rating implies that creditors would suffer losses of 35% to 65% on their investment in the event of default.

WHAT HAPPENS WHEN A COUNTRY DEFAULT?

Often, investors and the failing government negotiate a settlement in which bondholders receive new bonds that are worth less but give them at least partial compensation. It is difficult, however, to see how this could be the case now with the ongoing war and Western sanctions prohibiting many transactions with Russia, its banks and companies.

In some cases, creditors can sue. In this case, the Russian bonds are believed to come with clauses that allow a majority of creditors to agree to a settlement, and then impose that settlement on the minority, thus avoiding lawsuits. Again, it’s unclear how this would work as many law firms are reluctant to deal with Russia.

Once a country defaults, it may be cut off from borrowing in the bond market until the default is resolved and investors regain confidence in the government’s ability and willingness to pay. The Russian government can still borrow rubles at home, where it relies primarily on Russian banks to buy its bonds.

Russia is already suffering the severe economic consequences of the sanctions, which have driven down the ruble and disrupted trade and financial relations with the rest of the world.

Thus, the default would be one more symptom of Moscow’s wider political and financial isolation following its invasion of Ukraine.