Economy 2 March 2022, 1:19pm

Russia has effectively declared technical default

Portfolio

Foreign investors are effectively stuck with their holdings of Russian stocks and rouble-denominated bonds after the central bank put a temporary halt on payments and major overseas' settlement systems stopped accepting Russian assets.

Russian state withholds payments

The central bank of Russia has banned coupon payments to foreign owners of rouble bonds known as OFZs in what it called a temporary step to shore up markets in the wake of international sanctions, Bloomberg reported.

It could leave foreign investors who held almost 3 trillion rubles (USD 29 billion) in the debt at the start of February unable to collect income on their holdings, which are already blocked from sale by restrictions.

The next coupon payment on OFZ bonds is due tomorrow on notes maturing in 2024, according to data compiled by Bloomberg.

Viktor Szabó, fund manager at Aberdeen Asset Management in London told the news agency

Russian authorities underestimated how far sanctions will go and now do not have much left to do.

The share of foreign investors has risen to 19.1% by 1 February. OFZ yields jumped by nearly 2.5 percentage points last week as investor sentiment was hit when President Vladimir Putin first recognized two breakaway regions in eastern Ukraine and then launched a military attack on the rest of the country.

There is still no trading in rouble debt as Moscow put a stop to local bond auctions even before the invasion.

Russia's central bank announced on Monday it would tighten capital controls with a ban on transferring foreign currency abroad. Bloomberg said that while initially it clarified that the step was not aimed at stopping the servicing of debt, some investors and economists said the phrasing of the decree could amount to a default.

Foreigners stuck

Foreign investors are effectively stuck with their holdings of rouble-denominated bonds, known as OFZs, after the Russian central bank put a temporary halt on coupon payments and a major overseas' settlement system stopped accepting Russian assets, Reuters reported.

The National Settlement Depositary (NSD), a Russian version of the world's biggest settlement systems, Euroclear and Clearstream, said it was limiting payment options on Russian securities for foreign

On Monday, the Bank of Russia ordered depositories and registries operating on the securities market to freeze security sales by foreigners. It did not specify how long the curb would last.

The move to shut down trading in Russian assets are part of wider measures by Moscow to shore up its financial system after Western countries levied a raft of economic sanctions to punish Russia for its invasion of Ukraine.

Belgium-based Euroclear said in a note on Tuesday that it will no longer accept the rouble as a settlement currency, effectively shutting off an exit route for overseas investors.

Euroclear said the NSD had blocked its accounts as a result of the central bank measures.

Technical default?

“This will likely be a technical default, we’ll see how long it goes on for,” said Nick Eisinger, co-head of emerging-markets active fixed income at Vanguard Asset Management in London. “We also see strong likelihood of technical default on Eurobonds at the sovereign level,” he told Bloomberg.

Sovereign ruble bonds collapsed last week, sending the yield on the 10-year benchmark up 240 basis points to 12.28%. The ruble’s drop of more than 20% so far this year is the worst slump globally, prices compiled by Bloomberg show.

“A potentially weaker willingness on the part of the Russian government to service its debt on time and in full, raise the probability of more severe credit outcomes for foreign holders of Russian debt securities,” Moody’s Investors Service said in a statement.

A technical default in the financial world is when a state defaults on an obligation. Typically, this type of default is first encountered by creditors, as heavily indebted countries will sooner or later run out of money and, for political reasons, will refuse to meet a foreign investor's claim before they reject public wage or pension payments.

While the current Russian situation may formally appear to be a partial / technical default (usually formally stated by credit rating agencies), it is different in that it is not the forced move of a heavily indebted country on the verge of default (for now). The Russian state has ample resources, and 'non-payment' is an autonomous decision. However, there are three reasons why the Russians are taking this step:

On the one hand, the move can be seen as a response to the sanctions imposed for attacking Ukraine.
But it is more than that. The move, which is tantamount to a crippling of the sovereign debt market, does not hurt the Russians because foreign countries have already been de facto unable to trade in Russian government bonds. And in a situation of 'economic warfare', it no longer makes sense to enrich foreign countries with Russian interest rates.
Capital is fleeing Russia through all possible channels. Foreign players would also try to get the interest paid out of the country immediately, which would put further pressure on the foreign exchange market, and the ruble has already fallen to historic lows on the FX market, even drastic measures by the central bank could not save it.