Government defaults are not uncommon. Russia defaulted at $73 billion in 1998, Argentine defaulted at $ 82 billion in 2001, Greece defaulted twice in 2012 at $305 billion and the list continues. Until February 2022, creditors & banks had the appetite for lending Russia since its credit rating was BBB by Fitch, Baa3 by Moody’s and BBB- by S&P with a stable and/or positive outlook given that Russian foreign debt ratio to nominal GDP is approximately 27% until December 2021 compared to 31.4% in the previous year with foreign cash reserves of USD 640 billion aside of gas and oil daily revenues. The Russian federation currently owes other nations an average of $140 billion of which approximately 70% is in corporate debt; $25 billion to each Italy and France, $17.5 to Austria, $14.7 billion to the USA, $10 billion to Japan and $1.7 billion to south Korea.
Kristalina Georgievas, managing director of the IMF stated that Russia is pushed to artificial default as the government’s foreign cash reserves are frozen due to international sanctions adding to that, Russian officials informed foreign creditors that they would pay back debt interest in Russian Rubel instead of Euro or USD. A debt issuer should pay back both debt interest & initial investment at maturity in the same currency of which the debt is issued unless the debt issuer includes a “Fallback option” in the debt agreement. A Fallback option offers the debt issuer the advantage of full or partial payment of debt interest and/or capital at maturity in a different currency than the one (primarily USD or Euro) issued. Below is the Russian sovereign foreign debt:
As mentioned by Bloomberg, the ICE data service suggests 71% chance of default within one year and 81% within five years. Moreover’. It costs $5.8 million upfront and $100,000 annually to insure $10 million of Russia’s debt for one year. That compares with about $3.8 million in advance last week up from just $300,000 annually -- about 300 basis points -- before Russia’s invasion of Ukraine. Credit-default swaps switch to upfront pricing when perceptions of default are imminent. The below chart is for Russia’s CDS 5 years. As demonstrated, the yield recorded 15% as of today versus its peak at 22% prior meeting debt payment deadline. This highlights the market’s current volatility and debt crisis which insurance companies might face regarding credit default swap incase Russia defaults at future payments as of April 2022.
The Russian default risk would surely ripple to other emerging European, Asian and middle eastern economies where Interest rates will hike in emerging markets if Russia defaults, simply because these markets will face capital flight to developed less risky financial markets. That, will negatively affect emerging & developing markets’ financial statements enduring higher cost of debt. The below chart is for Bloomberg emerging market local bonds ETF versus iShares US government bond ETF demonstrating cash flows reaction to the Ukrainian/Russian conflict given that the current drawdown for the iShares is 0.8% versus 5% for the emerging markets ETF.
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