Davide Barbuscia, Sujata Ro

NEW YORK/LONDON – Russia faces a rare type of debt crisis. According to investors, this will be the first time a significant emerging market economy would see a geopolitical pressure on them into defaulting on their bonds.

Before the Kremlin attacked Ukraine on February 24, many would not have considered the possibility that Russia might default on its hard currency bond. Investors in emerging markets love Russia’s solid solvency record, high export revenue and inflation-fighting central banks.

Moscow has been on the verge of default since the U.S. Treasury decided not to grant a licence that would allow Russia to pay its debt payments, despite broad-ranging sanctions.

Russian finance minister wired $100 million worth of interest payments to two bonds due Friday to its domestic settlement office. It will not be recognized as a default if it does not appear in the foreign bondholders accounts.

Even if the funds are approved, the payments for nearly $2Billion will be due before the year’s end. In late June, one must be resolved outside Russia. Experts predict that this task will not be possible without the waiver from the U.S.

Emerging market credit crises are not new. Russia reneged in 1998 on its rouble bonds. As a result, defaults have been caused in Venezuela and Iran by geopolitics.

However, Iran had only a small amount of its loan debt hit by U.S. sanction after the 1979 revolution. Venezuela was already in trouble before U.S. restrictions in 2019 forced $60 billion worth of sovereign and sub-sovereign bonds across the brink.

Russia continues to earn oil and metals profits. The central bank is able to pay off the $40 billion worth of sovereign hard currency loans, despite having its war chest of $640 billion frozen.

Flavio Carpenzano is an investment director at Capital Group. He said that this crisis was different from any other emerging market crises. It’s not about the ability or willingness of Russia to pay.

It would also be Russia’s largest foreign bond default in a decade since its 1917 Bolshevik revolution. Russia has effectively been cut off from international financial markets by its sanctions as well as countermeasures.

Stephane Monier is chief investment officer at Lombard Odier. He said it’s inappropriate to make comparisons with Argentina in 2020.

Monier declared that “this would be the first default externally or politically driven in emerging market’s history.”

Due to the expiry of the Treasury license, creditors might not receive any payments. Daniel Moreno from Mirabaud Asset Management is head for global emerging market debt. He compared it to “turning around the world upside-down.”

He added, “Me the creditor is not now willing to accept payment.”

WE ARE NOT GOING BACK

Russia’s international bonds that were traded above par in the beginning of the year have seen their value drop to 13 to 26 cents on the dollars. The indexes have also removed them.

The key difference between Venezuela and Argentina is the fact that Russia has attacked Ukraine, calling it a special operation. This makes it an investor’s pariah.

Gabriele Foa is the portfolio manager at Algebris Global Credit Opportunity Fund. She stated that there’s a stigma associated with holding such bonds. Clients are putting pressure on emerging market asset managers asking them to not invest in Russia, and she advised them to sell their position.

A potential default will be symbolic for now because Russia is unable to borrow internationally and does not need to. What comes next is important.

Russia may be able to end Western sanctions by implementing regime change.

First, however, creditors must face an expensive and lengthy process of recovering money. This could include exchanging defaulted bonds for new ones.

A default stigma will also lead to higher future borrowing prices.

This will likely happen in Russia as well. By defaulting, “you raise the cost of financing and it is very likely that this will happen too.” Capital Group’s Carpenzano stated that they will have to pay a premium.

Although the White House anticipates that default would have minimal effect on the U.S. economy or global economies, Carpenzano believes events in Russia will force a review of geopolitical risks to emerging markets.

He said that geopolitical noise had increased, and investors want to be compensated. Citing China’s recent large investment outflows, he spoke of the higher risks.