The Russian state is set to fail to pay a coupon on bonds to foreign bondholders for the first time since 1998.
It is assumed that holders of government bonds denominated in rubles due in 2024 will receive payments on Thursday in exchange for a coupon due the previous day. Investors in Europe who own the bond say they have not received it or any notifications that it is on its way.
The National Settlement Depository Center of Russia reported that the Ministry of Finance sent interest payments, as usual. In normal times, the depositary then transfers it to the bondholders’ accounts with payment due for delivery on the next day. But because of Russia’s retaliatory response to Western sanctions, the money is stuck in the hoarded financial infrastructure, creating the conditions for Russia’s first potential default in more than two decades.
Banning the Central Bank of depositors and registrants from making payments to foreign customers earlier this week. These are part of the system that links issuers and debt holders. The central bank said in a statement that the issuer of the bond can pay to the accounting system, but the depositary is prohibited from sending this to foreign clients.
“Obviously they see this as an economic war, and this is their way of hitting the foreigners,” said Paul McNamara, director of the emerging market bond fund at the Greater Amman Municipality.
The move is part of a wide range of capital control measures that have been enacted since the invasion of Ukraine. The measures include a ban on foreign currency transfers abroad and a ban on foreign investors selling assets. Investors are beginning to write down the value of their Russian assets, from fund managers with non-tradable assets to oil giant BP Plc’s exit from the company. Share in Moscow-based Rosneft Which she said could cause a loss of $25 billion.
It was the last time Russia didn’t pay its bondholders August 1998When oil prices fell, low tax collection and faltering reforms forced Russia to default on its debt and devalue the ruble.
The standard practice for bonds is a 30-day grace period once payment is lost, according to securities settlement provider Clearstream and capital markets attorneys. If bondholders do not receive it by the end of the period, a default can be called. The 6.5% coupon is worth 22 billion rubles, which is equivalent to 210 million dollars.
If you’re a foreign bondholder and hold Russian local government debt, you may end up being unable to do much. “You can try to enforce bond terms, but in practice I doubt that would be difficult,” said Jamie Durham, partner focused on debt capital markets at law firm Allen & Overy.
Even if the Russian Finance Ministry technically paid the coupon, “from the bondholders’ perspective, they were not paid,” Durham said.
Russia was in the strongest financial position in years before the invasion. Having faltered in 1998, Russia is slowly returning to building goodwill with foreign investors. The Central Bank took a serious stance in curbing inflation and accumulated $630 billion in international reserves thanks to the current account surplus backed by high oil prices. Rating companies have upgraded Russia to the coveted investment grade category, which indicates a low probability of default.
Most of Russia’s local currency bonds are held locally and these bond holders can still pay their coupons. Foreign ownership of the Russian local currency bond market was less than 20% in February, according to Russian Central Bank data. Their holdings were estimated at 3 trillion rubles at the end of January, according to the Institute of International Finance. That’s about $25 billion at the exchange rate on Thursday.
In terms of the broader world of emerging market bonds, Russia has been a small but not minor player. It accounted for about 6% of the popular local currency emerging market bond index JPMorgan Chase & Co as of last week.
The Western sanctions were a quick hit, with the three rating companies cutting the country’s sovereign rating to junk category in the past five days. Moody’s and Fitch cut its rating by six notches on Wednesday.
Fitch has downgraded it to B, meaning it sees significant default risk. The company cited uncertainty about the Russian government’s willingness to repay the debt as the reason.
Rating companies judge a borrower based on his ability and willingness to pay his debts. In the case of Russia, if it defaults, it will be due to choice, not insufficient funds.