Russia faces another threat of default on May 4, according to major rating agencies, as the grace period draws to a close after trying to repay its dollar bonds in Russian roubles.
Mikhail Tereshchenko | sputnik | via Reuters
Although Russia has so far avoided a historic default since sanctions were imposed on its foreign currency reserves, analysts believe it is delaying the inevitable.
Last week, Moscow made payments to holders of two dollar-denominated Russian sovereign bonds, maturing in 2022 and 2042 and collectively worth $650 million, before the end of a 30-day grace period on May 4.
The Russian Finance Ministry first tried to make the payments in rubles on April 4 when the US Treasury Department blocked an attempted payment from dollar reserves held in US banks. Much of Russia’s Central Bank of Russia’s vast currency reserves held with foreign banks have been frozen by international sanctions imposed following its invasion of Ukraine.
Major rating agencies said it would have been the country’s first foreign debt default since 1917 had Russia failed to meet its foreign currency obligations by the end of the grace period. Russia found a source of funds that was not subject to sanctions, allowing payments on both bonds.
The successful delivery of payments has prompted a rally in hard currency Russian sovereign bonds, but Russian government bond prices remain well below levels seen prior to Russia’s invasion of Ukraine on Feb. 24.
In a note last week, MSCI Research said that despite the rally, “implied default probabilities in the credit default swap market were still exceptionally high over the one- and five-year horizons.”
“Although the resulting rally in Russian sovereign bonds may have encouraged some investors to believe that Russia will avoid default, implied default probabilities in the credit default swap (CDS) market were still exceptionally high on one- and five-year horizons,” he added. said Andy Sparks, chief executive of MSCI, and Gabor Almasi, vice president.
“As of May 3, the one-year probability of default was 67%, compared to over 95% on April 26. Over the same period, the five-year default probabilities increased from 99% to 88%.”
All eyes to May 25
Russia has benefited from a US sanctions waiver that allows bond payments on Russian sovereign debt to be made from sources authorized by the Treasury on a case-by-case basis.
However, this exemption expires on May 25 and MSCI has suggested that unless extended it could trigger an event of default when multiple Russian bond payments are due on May 27.
“Alternatively, the exemption extension could provide additional payments to bondholders as long as the Russian government signals its willingness and ability to continue making payments,” MSCI added. The Treasury has not yet indicated whether it plans to extend this exemption.
By servicing the $650 million in coupon and principal payments last week, Russia’s Finance Ministry has shown it does not want a default and understands the consequences would be “extremely damaging and long felt”. according to Timothy Ash, senior sovereign emerging markets strategist at BlueBay. Asset Management.
Ash agreed that the key question now is whether the US Office of Foreign Assets Control will extend the general license for foreign debt service beyond May 25.
“One view has been that it is advantageous for the United States to allow Russia to tap into the scarcity of FX (foreign currency) liquidity beyond that frozen by the West. But in fact, I think the benefits of seeing that liquidity reduced ever so slightly with a few billion dollars of external debt service here and there pales when you think about the economic and public relations impact of a sovereign default in Russia,” Ash said. in an email Friday.
“The Russians themselves revealed their own cost-benefit calculations by paying earlier this month – so OFAC’s interests are now surely the opposite.”
Ash questioned why OFAC would extend the license given that it would be “obviously to Russia’s benefit”, and suggested that a more pertinent question would be whether Russia can still find a way to avoid the default if OFAC refuses to extend.