By Karin Strohecker

LONDON (Reuters – Russia’s 640 billion dollar reserves are under Western control and there is a fear that sanctions will cripple cross-border capital flows. Investors worry Russia might default on its sovereign hard currency debt.

After the central banking temporarily halted coupon payments, and Euroclear’s settlement system stopped accepting Russian assets, foreign investors were left with OFZs.

An example of a Russian default in roubles is that Moscow broke off OFZs during 1998’s financial crisis. But even so, the country continued paying dollar bond payments. This Russian default wasn’t on anyone’s radar before the recent Western-imposed sanctions that froze assets of central banks.

This is partially because Russia calls its actions in Ukraine “special operations” and has only $40 billion of international bonds across issues 15-dollar- or euro-denominated. Its total outstanding amount is small compared to its peers.

While the bonds traded above par up to mid-February due to Moscow’s troop building-up at Ukraine’s borders and U.S. warnings about an imminent invasion, investors ignored them.

In just two weeks, many bond investors believe that default is possible. Russia’s credit premium has increased and credit default Swaps (derivatives used for exposure insurance) are at an all-time high.

Some dollar bonds are now priced at below $30 per dollar and trading volume is low.

Russian hard currency debt is held by half of the foreigners. Russia must pay $107m in coupon coupons to its two bondholders on March 16.

“Will Russia pay? “There’s a great deal of uncertainty right now, following the sanctions applied the Russian central bank & the ministry of finances,” Marcelo Assalin said, head of emerging markets debt at William Blair, an investment manager and financial service firm in London that holds Russian debt.

JPMorgan (NYSE 🙂 and IIF (global banking lobby group), both warn of a rising risk that Russia may default on its external debt.

March 16 marks the beginning of many payments. A third payment, $359m due on a bond for 2030 due on March 31, will be due. After a $2B bond matures, April 4 is the due date for principal payments.

SWIFT-ACTION

Russia’s reserves should be sufficient to repay its debts. However, in practice the assets freeze has reduced what Russia has to pay its creditors.

Second, payments can be harder to execute after Moscow was denied access to SWIFT’s global payment networks. Finally, asset freezes reduce Russia’s capacity to defend its currency and raise the cost of servicing foreign loans.

Dirk Willer from Citi New York, Head of Macro, Asset Allocation and Emerging Market Strategy, said that “freezing FX reserves could substantially weaken the ruble and increase default fears for sovereigns and corporations.”

Reuters reached out to the central bank and finance ministry for clarification on possible defaults.

Russia may be able, with cash available and without SWIFT, to still pay. However, many believe Russia has no incentive to do this due to its targeting of offshore savings.

Moody’s, a rating agency (NYSE:), stated that “Western governments’ determination to isolate Russia from the international finance system, coupled with a potential weaker willingness by the Russian government, to service its debt in full on time, increase the likelihood of severe credit outcomes for foreign owners of Russian debt securities.”

Moscow already prohibited foreign investors from purchasing Russian assets, and suspended payments to foreign securities funds temporarily.

Moody’s believes the decision reflects an “increasing lack of predictability in policy decisions.”

Moody’s, which has its credit rating of Baa3 Russia on downgrade review Friday, did so. Hours later S&P Global (NYSE:) cut its equivalent investment grade Russian rating to ‘junk’ and immediately put it on another downgrade warning.

JPMorgan noted that bonds are issued with both indentures as well as terms. Bonds that were sold following Russia’s 2014 annexation and annexation Crimea have a provision to allow for other currency payments.

According to documentation, payments may be made in US dollars, euro or British pounds if Russia cannot make interest payments and payments for reasons that are beyond its control.

The rouble can be used as an alternative currency to bonds since 2018. JPMorgan Notes.

The grace period on most eurobonds is 30 days for principal and coupon payments. Morgan Stanley (NYSE:) The earliest default date could be April 15. This is when the grace period ends on the bond coupon for 2023.

In Russia, the 35 billion dollar market for corporate debt has seen default worries. Gazprom must pay a $1.3billion bond to the state on March 7, which is an indicator of Moscow’s approach towards foreign creditors.