Russia - thoughts on default and debt restructuring

Interesting tug of war now developing around Russia’s ability/willingness to pay external creditors and therein prospects for default.

Sanctions have certainly complicated Russia’s ability to pay - with sanctions on the CBR putting a sizeable portion of its FX reserves now beyond reach of the sovereign. However, OFAC has issued a general licence specifically allowing for sovereign debt liabilities to be paid.

See below:

https://home.treasury.gov/system/files/126/russia_gl2.pdf

Actually from a Western government perspective, they have an interest in Russia running down its remaining accessible FX assets to pay foreign creditors. This further erodes free Russian FX assets.

The Russian side is giving mixed signals. 

At present the message seems to be that the MOF is willing and able to pay, but is being prevented from so doing by sanctions on the CBR. So the message from Russia is if the West wants Western creditors to be paid, then sanctions on the CBR need to be freed/eased. It has even issued a directive saying that it will make payment in FX for debt service through foreign correspondent banks, but if these banks are unable to transact with the CBR because of sanctions, then monies owed will be paid in rubles but held at the National Security Depository (NSD) and payment then made at some point in the future via so called “S” accounts. This could well constitute a default, but the MOF will try and argue, “it’s not our fault, we tried to pay, and did pay, but non payment is the result of sanctions, so beyond our control”. That said, the invasion of Ukraine, is the responsibility of Russia, so it is hard for them to argue then that any such default is really not their fault.

The first test of all this will come this Wednesday and a $117m interest payment on a sovereign Eurobond which predates the 2018 move by the MOF allowing payment in new Eurobond issues in rubles - the strange shift from 2018 suggests that the MOF had an inkling of events that have come to pass with more aggressive sanctions on sovereign debt.

While in one respect the MOF would like not to be able to pay their foreign creditors as this a) saves now scarce FX reserves; b) hurts investors in adversary nations, and they then hope these will lobby their own governments for sanctions relief, the downside is that non payment and potential default would have serious and long run consequences for Russia. A default would see Russian ratings cut to default status, and given likely difficulties in ensuring speeding debt restructuring, this status could remain for a very long time. This would keep Russian borrowing costs very high, liming financing options even from so called allies, such as the Chinese. Even should the war end quickly, and peace be resolved, markets and ratings agencies will remember this crisis for some time and ratings will be slow to recover and Russian borrowing costs slow to moderate. This will crimp Russian economic development for years to come.

Come Wednesday likely some money will have been paid, perhaps with some delay. But the question is will foreign investors be able to access it and in what form/currency, and then the debate with ratings agencies, et al is does this all actually constitute a default. This all might end up in the courts.

When it comes to debt restructuring talks, assuming a default is eventually called, these are likely to be incredibly complicated and long winded. As a stating point it is hard to see any talks being possible while the conflict is still on going, and sanctions remain in place. Creditors will have major ESG related issues in engaging with a sanctioned sovereign. Indeed, for any such negotiations they would need special dispensation from Western governments. Even then, debt restructurings are seen as part and parcel of a sovereign’s rehabilitation after an economic crisis - they are driven by a desire to ensure some recuperation of losses suffered by creditors but also a return to market access by debtors. In this case Western governments are likely to have zero interest in helping Russia regain market access - indeed, Russia is still likely to be sanctioned therein. Even assuming sanctions are moderated, with some kind of ceasefire or peace deal, it is hard to see sanctions being significantly eased, or indeed relations are unlikely to be significantly improved. Through its invasion of Ukraine, Russia has clearly marked it out as an ardent adversary, even enemy, of the West - and its hard to see this changing very quickly. The West will have a strong interest in keeping Russia contained, both militarily and economically. They will have little interest in opening the floodgates again to Western financing of Russia. And as agreement on a debt restructuring is a key initial requirement, I think the West will look to drag its feet. So think here more Venezuela style debt restructuring talks, than a speedy conclusion as per recent Ecuador or even Ukraine 2015.