The term “collateral damage” doesn’t just apply to literal warfare, after all. Everyone knew that the level of economic sanctions imposed on Russia by the West would have lots of secondary and tertiary effects. That now includes a rising potential for Russia to default on its debt — which could create plenty of economic pain outside of Russia.
Bloomberg notes that the odds of a Russian default are a lot higher than one would imagine and that it could come as early as a week from Wednesday:
The cost of insuring Russia’s government debt rose to a record high after President Vladimir Putin signed a decree allowing it to repay foreign creditors in rubles, raising concerns about the prospects of a default across the country’s $33 billion of dollar bonds.
Credit-default swaps insuring $10 million of the country’s notes for five years were quoted at about $5.8 million upfront and $100,000 annually on Monday, signaling around 80% likelihood of default, according to ICE Data Services. ICE is the main clearing house for European CDS. The upfront cost that protection sellers demanded on Monday rose from around $4 million last week.
The decree announced over the weekend said that repayment in rubles could include securities denominated in other currencies. While some of Russia’s international bonds allow repayments in rubles, the two dollar bonds with $117 million worth of coupons due on March 16 don’t have that option. Investors are concerned that Russia could trigger default swaps if it decides to repay those bonds in rubles.
“The CDS has blown out wider after Putin’s declaration that some debts will be paid in RUB despite being denominated in USD,” said Anthony Kettle, a senior portfolio manager at BlueBay Asset Management. “It’s still unclear, but that could be an event of default for the March 16 coupon.”
The default itself can’t be seen as a surprise. Indeed, it’s practically the purpose of the sanctions regime imposed by the EU/G-7 — to force the Russian economy into collapse unless Putin withdraws from Ukraine. The speed of that potential collapse, at least in terms of its debt position, might surprise some observers, but it couldn’t come as a shock to the investors who hold those debts. After all, they knew when those payments were due, and knew full well (or should have) that the sanctions on the Russian Central Bank blocking currency exchanges would force a default — or at least some restructuring.
Of course, Russia’s creditors could agree to accept rubles at current exchange rates, but …. that’s a pretty grim fallback option, one that got worse today:
The ruble fell 10% to as low as 135.49 against the dollar, after the US and its allies discussed further retaliation against Russia’s invasion of Ukraine via a ban on imports of its oil.
That level puts 1 ruble at seven-tenths of 1 cent, or $0.0073. The Russian currency is now down 38% this year so far, but the decline is not as severe as during the 1998 Russian financial crisis, when it plunged 70%.
What would a Russian default do to Western financial institutions? It’s tough to say, but until very recently no one would have priced that into their investment-risk calculations. The price of oil alone would have made Russian government debt a reasonably safe investment, even in dollars, despite the slow ratcheting of tensions since the 2014 invasion of the Donbas. Certainly it has looked worse over the past couple of weeks, but it’s too late for second-guessing now, especially since Putin made it impossible for investors to get out.
The answer to the question of collateral damage from a Russian default might depend on just how far the risks of Russian debt have been monetized and spread through Western institutions. The 2008 financial crisis in the US was caused by highly monetized bad debt from Fannie Mae and Freddy Mac, which turned out to have well over $1 trillion in toxic assets but which led to a decline of $11 trillion in household wealth over the course of a year. Russia’s entire national debt only amounts to $200 billion in US dollars, though, and the defaults would only relate to a portion of those funds. Until the last couple of weeks, their debt only came to 20% of Russia’s GDP, but the sanctions will create a big hole in GDP for the time being. It would damage some large investors and might rattle a financial institution or two that overextended itself on Russia. To the extent it causes any real damage, Western governments might spend some money on shoring them up, but it’s not likely to be a catastrophe.
Inside Russia, the catastrophe is already under way. Putin still has his stock market shuttered, and Russian investors have nowhere to turn as their wealth evaporates in Western markets. How long before Putin hits reverse and prevents a total wealth collapse in Russia? It may take longer than we think, because as John Schindler writes today, Putin thinks he’s on a mission from God. Literally:
As this newsletter has already explained, Putin’s aggression against his neighbor isn’t grounded merely in coldly rational geostrategy: it has a significant religious component too.
Although it’s been almost wholly ignored by Western “experts,” the Kremlin has made abundantly clear that it’s gone to war against Ukraine to heal the schism in world Orthodoxy that it believes was birthed by the United States in 2019 when Washington enabled the creation of the Orthodox Church of Ukraine out of elements of the long-existing Ukrainian Orthodox Church, which ultimately reports to Moscow. …
Moreover, yesterday was Forgiveness Sunday in the Orthodox world, the beginning of Lent, and the head of the ROC took that opportunity not to forgive, rather to justify the Kremlin’s war being waged on fellow Orthodox Christians, during Lent no less, due to gay pride parades.
The ROC’s condemnation of recent Western LGBT practices, including gay pride parades, an objection which Western post-moderns have difficulty understanding, is hardly new. … Putin and his regime have forged close ties with the ROC in a mutually beneficial relationship, a 21st century take on what Orthodoxy terms symphonia. There’s no reason to think that Kremlin grandees dissent from Kirill’s incendiary take on why Russia must wage war on Ukraine (and if they do, they know to keep quiet). Furthermore, there’s evidence that such thinking has permeated Russia’s military and security services too. Ukrainian military intelligence has captured an apparently authentic Russian military officer’s handbook which describes Putin’s army as “the last bastion against the Satanic new world order.” There’s ample evidence that such religiously-inspired apocalyptic thinking has infiltrated many minds in Moscow, including highly-placed ones, an alarming prospect which implies there will be no easy end to Russia’s aggression against Ukraine.
That’s not exactly a cheery prospect, is it?