A potential Russian debt crisis carries unpredictable risks

Russia’s debt problem today is much different than in 1998, when financial turmoil and a liquidity crunch forced Moscow to forgo payments to national bondholders in a financial event that spread worldwide. This time Russia has plenty of money, but much of its reserves have been frozen by US, European and Japanese officials as punishment for its invasion of Ukraine.

To mitigate the negative impact on the global financial system, the US Treasury said it would allow Moscow to transfer frozen funds to cover its foreign bond payments through May 25. But think of it as a limited insurance policy – we could run out at any minute.

This is partly because Russian President Vladimir Putin has suggested that foreign creditors in “hostile” countries could be paid in unwanted rubles instead of dollars or euros.

Above all, the Russians did not move in this direction last week. But Moscow has nearly $2.86 billion in interest and bond payments due by April 4, according to the Institute of International Finance (IIF), an industry association. If Moscow tries to pay in the modest rouble, such a move will amount to a sovereign default, the ratings agencies said. It would be the first for Russia on its foreign debt since the Bolsheviks halted payments in 1918.

Such events in the past have infected the global system with “contagion”, or a financial domino effect that spreads when panicked investors rip money from foreign countries, knocking down their borrowing costs, stock markets and change rate.

There is good news now. The global economy is significantly more stable today than it was in 1998, a tumultuous period when Russia’s default was sandwiched between the 1997 Asian financial crisis and a well most devastating in 2001 in Argentina. At the time, many emerging markets were plagued by fragile monetary systems and high dollar-denominated external debt – financial risks that many countries have since reduced.

Large Western fund managers, pension funds and other institutions that hold large amounts of Russian debt will feel the effects. But Russia isn’t even among the top 10 global economies measured by gross domestic product, and the pain should be relatively contained. Russia owes $62.5 billion to its foreign creditors, including $21.5 billion that must be repaid in dollars and euros. It’s not much in the overall scheme of things.

“Most likely a lot of it will have to be rolled back,” Elina Ribakova, deputy chief economist at the Institute of International Finance (IIF), an industry association, told me. “It will be unpleasant. And there are global pension funds, you know, in the UK, in Europe and in the US that are involved in this. But we are watching the signs in the market and we don’t see any big upheavals. »

But there are also some very big wild cards to consider.

We now live in an era of exotic financial instruments such as credit default swaps – or contracts that allow investors to hedge their financial bets – which can quickly become toxic and cause a financial crisis, as the world has learned from the 2008 US subprime mortgage crash. Few people predict a repeat of that now. But the extent of global exposure to swaps and other Russian debt-related liabilities is still difficult to assess.

World Bank chief economist Carmen Reinhart raised the specter of long-term capital management (LTCM), a hedge fund that required a massive bailout due to the 1998 Russian default.

“Do you remember LTCM? It wasn’t necessarily on anyone’s radar screen at the start of the Russian default in August 1998,” Reinhart told Bloomberg News. “These things are starting to surface. Exhibits are opaque.

In addition, the financial pain of the war will particularly affect countries closely linked to Russia and Ukraine by commercial ties, including Turkey, the Czech Republic, Hungary and Poland.

The biggest fallout from the war on the global economy remains Russia’s impact on commodity prices. Moscow is a major exporter of oil, gas, metals and grain – and trade disruptions from war and Western sanctions have already pushed up commodity prices, adding to already bad global inflation. Domestically, Russia is also likely to face years of financial isolation as foreign investors shun it. Its heavily indebted companies are also facing new credit hurdles, and fears are growing over the growing default risks of Russian companies.

Russia’s defaults – whether by its government, its companies or both – could have further ripple effects by accelerating currency flows and already raising borrowing rates in a host of countries. , putting pressure on nations’ ability to fund social programs, build infrastructure and repay their own debts. In 1998, the Russian debt crisis triggered a run on the Brazilian real and a spike in interest rates. Even the US dollar plunged massively against the Japanese yen following Russia-related LTCM losses.

Global monetary policy is far more stable now than it was then, but global borrowing costs are already rising as the Federal Reserve decides to raise interest rates and end to what was a worldwide flow of cheap money. It comes at a time when the pandemic era has seen a historic rise in national debt burdens, particularly for emerging markets, as countries struggle to cope with economic downturns and exploding utility costs. health and social care. Sri Lanka, for example, is currently going through its worst economic crisis since its independence in 1948, requiring financial lifelines from India and potentially the International Monetary Fund.

Borrowing costs for emerging markets have increased since the Russian invasion, especially for countries with high exposure. Neighboring Georgia suffered the most. But so does Egypt, which is heavily dependent on grain exports from Ukraine and Russia.

They won’t be the only ones feeling the pain, especially if Russia defaults completely.

“There are risks… for countries with high external financing needs, especially in foreign currency,” Ribakova said. “Turkey comes to mind. Anyone with high external funding needs. This is where the contagion is most likely to be felt. »