Russia in default - so what?

Actually this is really important

Don’t believe the media hype that this is the first Russian default since 1918. 

That’s just stretching the reality.

As someone who was there in 1998, working in Russian markets, I can assure you that Russia defaulted in 1998. Absolutely, no doubt. 100%.

Russia defaulted on around $100bn in debt liabilities in 1998, restructured Soviet era FX liabilities - PRINS and IANs (investors eventually took a one third haircut) then around $60bn in local ruble debt, GKOs (mostly held by foreigners who got cents in the dollar), plus also various corporate debt.

The confusion arises as Russia avoided defaulting on post-91 issued Russian FX debt, the few Eurobonds it had issued post 91. Being there at the time this was more a fluke. When they failed to pay liabilities in August 1998 they had a few months until the next Russian era Eurobond fell due, in November that year, and managed to scrape the money together to pay that to pretend that the Russian Federation paid, when we all know they did not. This was just a PR stunt.

But those PRINS and IANs were still Russian Federation liabilities, as when the USSR collapsed the Russian Federation assumed all the assets and liabilities. It failed to pay the liabilities and hence the Russian Federation WAS IN DEFAULT in 1998. Some USSR successor states have argued that, given Russian failed to pay its liabilities, they should have been compensated in getting a share then of the USSR’s assets.

Try telling investors who lost their shirts in 1998 that the Russian Federation did not default. Complete bollocks!

It is interesting though now to ask the question does this matter?

Siluanov is banging the line that this is just a technical default, and Russia can pay and will pay, but that it is just being prevented from paying by the US Treasury. And I guess his line is that when the dust settles that everyone will forget this.

I doubt it.

First, it matters as it is embarrassing for Putin. I remember back in 2000, soon after Putin took office and on his first meeting with German chancellor, Schroeder. At that time the market was expecting a Paris Club restructuring. There was a meeting when the market expected Schroeder to offer Putin debt relief for Russia. To everyone’s surprise, Putin rejected it and said a sovereign power, like Russia, did not need bail outs from the West. So for Putin Russia paying its international obligations is a matter of national pride and, as he said, at the time, Russian great power status comes with paying one’s obligations.

Clearly Russia is not a great power then.

Second, default day might not have much market to market impact, as this has already been priced in. Russian sovereign longer maturity Eurobonds which were trading at 130 cents before the war, have already crashed to 20-30 cents, and are already trading at default levels. Indeed, Russian likely already defaulted on some ruble denominated instruments owed to foreigners in the weeks just after the invasion, albeit having pulled their ratings the ratings agencies were not able to call this a default.

But this default is important as it will impact on Russia’s ratings, market access and financing costs for years to come. And important herein, given the US Treasury forced Russia into default, Russia will only be able to come out of default when the US Treasury gives bond holders the green light to negotiate terms with Russia’s foreign creditors. This could take years, decades even, even assuming some kind of ceasefire but falling short of a final peace agreement. So Russia will have limited access to foreign financing, and will pay higher borrowing costs for years to come.

Now just imagine if Russia is still looking for alternative sources of financing beyond the West, for example from Chinese banks. Do you think that Chinese banks will be prepared to look beyond the default headlines? Hardly. If they are prepared to run the secondary sanctions risks - which so far they have not - and still lend to Russia, they will add a huge risk premium to lending rates for the prospect of somehow being dragged into future debt restructuring talks. It just makes lending to Russia that much more difficult. So people will avoid it. And that means lower investment, lower growth, lower living standards, capital and human flight (brain drain), and a vicious circle of decline for the Russian economy. And Russia might currently be basking in high oil and energy prices, but the carbon transition and accelerated Western diversification away from Russian energy and commodities means that this golden goose is cooked two to three years down the line. It might be on slow roast, but the goose will be inevitably cooked. 

So on a two to three years outlook Russia faces a collapse in export receipts, with almost no access to international financing because of sanctions and default. Meanwhile, with much of Putin’s military having been destroyed in Ukraine, he will struggle to finance military rebuild which he will be desperate to achieve given his desire to retain some kind of parity with NATO. That means that the Putin regime will have to divert all resources away from consumption to military investment. It will all have a feel of decay circa late 70s, early 80s Soviet Union. And decay and decline is the outlook here for Putin’s Russia and a large part of that is because of today’s default.