Down Debt

Russia risks missing interest payments for the first time since the 1998 crisis

The Russian state is set to not pay foreign bondholders a coupon due on a bond for the first time since 1998.

Holders of a ruble-denominated government bond maturing in 2024 are expected to receive a coupon payment due the day before on Thursday. Investors in Europe who own the bond say they haven’t received it or any notification that it’s on the way.

Russia’s National Settlement Repository said the Finance Ministry sent the interest payment as usual. Normally, the custodian would then transfer it to the bondholders’ accounts with payment scheduled for delivery the following day. But due to Russia’s retaliation for Western sanctions, the money is stuck in a jammed financial infrastructure, creating the conditions for Russia’s first potential default in more than two decades.

The central bank blocked custodians and registrars from making payments to overseas customers earlier this week. These are part of the system that connects issuers and creditors. A bond issuer can make a payment to the accounting system, but the custodian is prohibited from sending it to overseas customers, the central bank said in a statement.

“They clearly see this as economic warfare, and that’s their way of hitting outsiders,” said Paul McNamara, emerging markets bond fund manager at GAM.

This decision is part of a wide range of capital control measures adopted since the invasion of Ukraine. The measures include banning foreign currency transfers abroad and banning foreign investors from selling assets. Investors began to write down the value of their Russian assets, with fund managers holding non-marketable assets as oil company BP Plc exited its stake in Moscow-based Rosneft, which it said could generate a loss of $25 billion.

The last time Russia failed to pay its bondholders was in August 1998, when falling oil prices, low tax collection and stuttering reforms forced Russia to default on its debt and to devalue the rouble.

Standard practice for bonds is a 30-day grace period once a payment is missed, according to securities settlement provider Clearstream and debt capital markets lawyers. If the bondholders do not receive it at the end of the period, a default can be called. The 6.5% coupon is valued at 22 billion rubles, or $210 million.

“If you are a foreign bondholder holding Russian domestic government debt, you may not be able to do much in the end. You can try to enforce the terms of the bonds, but I suspect it will be difficult in practice,” said Jamie Durham, a debt capital markets partner at law firm Allen & Overy.

Even though Russia’s finance ministry technically paid the coupon, “from the bondholders’ point of view, they haven’t been paid,” Durham said.

Russia was in its strongest financial position in the years before the invasion. After defaulting in 1998, Russia has slowly rebuilt goodwill with foreign investors. The central bank has taken a serious stance on controlling inflation and has accumulated $630 billion in international reserves, thanks to a current account surplus supported by high oil prices. Rating companies have upgraded Russia to the coveted investment grade category, indicating a low probability of default.

Most Russian local currency bonds are held in the country and these bondholders can still receive their coupons. Foreign ownership of the Russian local currency bond market was below 20% in February, according to data from the Russian central bank. Their holdings were valued at nearly 3 trillion rubles at the end of January, according to the Institute of International Finance. That’s about $25 billion at Thursday’s exchange rate.

In terms of the broader universe of emerging market bonds, Russia was a small but significant player. It made up about 6% of JPMorgan Chase & Co.’s popular local-currency emerging markets bond index last week.

The blow from Western sanctions was swift, with all three ratings firms downgrading the sovereign to junk status in the past five days. Moody’s and Fitch downgraded it six notches on Wednesday.

Fitch has downgraded it to B, meaning it sees significant default risk. The company cited uncertainty surrounding the Russian government’s willingness to repay its debt as the reason for this.

Rating companies judge a borrower on both their ability and their willingness to pay their debts. In the case of Russia, if it defaults, it will be by choice rather than insufficient funds.