Russia - default/no default?
People I think still trying to figure out what happened here, who blinked first.
Last week the market was sure that Russia would not pay the Eurobond coupons due in April in dollars, but try and pay in rubles and would hence be called into default.
The pricing of the April 2022 Eurobond kind of reflected expectations, rallying up over 70 price points in a matter of hours as expectations of default were reversed, for the time being at least.
So what happened?
Well it seems like there was a game of chicken playing out between OFAC and the Russian MOF, each trying to figure out for whom a Russian sovereign default would hurt most.
OFAC did extend a general licence to May 25 allowing a carve out to allow external debt payments by Russia until that date, despite sanctions being tightened overall on Russian sovereign debt after the invasion on February 24. It then signalled that US entities should not help the Russian MOF to pay debt service from blocked accounts, and uncertainty was sown as to whether US, and US linked entities, would be allowed to facilitate the payment of debt service from unblocked accounts - sanctionable monies, but as yet not “found” and frozen by OFAC. The assumption in the market was that US/US linked entities might get caught out in secondary sanctions by facilitating payments from unblocked accounts. This uncertainty was reflected in market pricing of debt - but the assumption that Russian would be unable to pay in dollars, and would be forced to try and pay in roubles, and given problems paying foreigners holding OFZs made the market assume that foreign investors even paid in rouble would still not get paid. In the end it seems that US entities were given the green light to receive/process monies that had hitherto been beyond the reach of OFAC but which were sanctionable.
In the prior game of check Russia had assumed that OFAC would not want to penalise US and Western institutional holders of Russian debt, by allowing a default - foreigners are thought to hold around $20bn in Russian sovereign hard currency debt, albeit this is multiples lower than in the last sovereign default by Moscow in 1998. They argued that OFAC sanctions, by freezing CBR assets, had limited FX resources available to Russia to service external debts. They argued that they wanted to pay Western institutional investors but OFAC was preventing them doing so, risking pain to those same investors. By threatening to push payment in rubles they tried to pressurise OFAC to loosen sanctions to allow payment from frozen funds - in effect they did not want to reveal/draw down unfrozen funds, but also wanted OFAC to generally ease the sanctions regime around Russia. The MOF banged the line that any default would not be Russia’ fault but OFAC being unreasonable and hurting their own investors - no recognition that all this was due to Russia’s illegal war in Ukraine.
OFAC took the view that Russian would not want a sovereign default, which would have long lasting impacts on Russia’s sovereign credit worthiness and its borrowing costs. If Russia had gone into default even friendly countries, such as China, likely would have been reluctant to lend to Russia, unless at very high rates of interest. Default would in effect be a huge long term negative for Russia - keeping borrowing costs high, curbing investment and growth, and lowering living standards in Russia.
In the end it seems that OFAC took the view that if Russia paid from unfrozen funds, this would ultimately draw down FX liquidity for Russia, and this was a positive. Russia blinked in terms of it realised a default would have very long term consequences on its credit worthiness, and the price of $600-700m for these particular two Eurobond series was a small price worth paying to avoid that scenario.
Actually from OFAC’s view restricting Russia’s FX liquidity by less than $700m seems a small win, when Russia was allowed to avoid default which, as noted, would have huge longer term consequences. And from OFAC’s point of view it’s not as though even by forcing default this time would not leave it with no bullets left in the gun - if OFAC forces Russia into default, it still has the magic bullet left of being the entity which will determine when Russia comes out of default.
OFAC might have concluded that taking down another $700m was worthwhile given that the general license renewal only comes due on May 25, and might not be extended which would then likely make a Russia default difficult to avoid.
If does feel though as Russia got off lightly here, it paid a small price (less than $700m, and a drop in the ocean for Russia of the likely $300bn plus in assets still beyond the reach of OFAC, and the tens of billions in dollars it is still earning on a monthly basis from energy sales from the West) to avoid a default which would have huge and likely much bigger longer term financial consequences. Wondering here if OFAC missed a trick? Or did it conclude that it might not have had the legal/technical ability to all Russia into default?
https://www.ft.com/content/a0b41150-78aa-490d-a3eb-4e8bd7bcf155
Did OFAC conclude that Russia might have tried paying in roubles anyway and then played the legal card to argue it was not in default? This would then have surely weakened OFAC’s leverage over the longer term.