Doubts of possible default hang over Russian bond market

The big question now facing Russian debt holders is whether they will ever get their money back.

The government is paying the coupons on its bonds for now, but with the war in Ukraine and foreign reserves frozen, it’s unclear how or when investors will receive their cash.

Despite the central bank calling the ban on transferring coupon payments temporary, the financial collapse has been so severe that no one knows how it will be fixed or if Russia would have some motivation to pay the debt.

With decades of integration into the global financial system removed in days, Russia now risks its first debt default since 1998. In the past, fallout from the Asian debt crisis and falling oil prices forced the Government of Boris Yeltsin to renounce nearly US$ 40,000 million of local bonds.

Fitch Ratings on Wednesday cut Russia’s sovereign credit rating by six notches to “B” (deeply speculative grade). Moody’s Investors Service did so on Thursday, with a similar downgrade to a junk “B3” rating. Meanwhile, MSCI Inc. and FTSE Russell are removing Russian stocks from their widely tracked indices.

“We assume that US sanctions prohibiting transactions with the Ministry of Finance will not prevent servicing Russia’s sovereign debt“, said Fitch in your statement. “But this is not clear and the risk of such a severe measure has increased markedly.”.

Russia’s access to reserves, willingness to pay and mechanisms for making coupon payments will come into play. In early February, investors held nearly 3 trillion rubles ($30 billion) in local Russian bonds, known as OFZs.

Barring any announcement from the central bank or the government, it may be weeks before investors or ratings agencies can say with certainty that Russia has defaulted.

Most bond deals come with a 30-day grace period to give borrowers some wiggle room. It is not clear if the OFZ bonds have the same provision, nor the conditions.

Several analysts, lawyers and bond investors interviewed by Bloomberg said they did not know whether the Russian case, in which a coupon is paid on accounts that investors cannot access, would be considered a default.

Others have speculated that ratings agencies may call it a technical default, meaning Russia failed to meet the terms of the bond deal. Moody’s and S&P they declined to comment when contacted by Bloomberg.

The world’s largest clearinghouses, Euroclear and Clearstream, no longer liquidate Russian assets and some of the country’s largest banks are cut off from the global banking system. Capital controls imposed by the central bank mean that despite the finance ministry transferring a planned bond payment on Wednesday, investors are unable to get the money.