Dollars or Rubles? Russian Debt Payments Are Due, and Uncertain.

Russia is teetering on the edge of a possible sovereign debt default, and the first sign could come as soon as Wednesday.

The Russian government owes about $40 billion in debt denominated in U.S. dollars and euros, and half of those bonds are owned by foreign investors. And Russian corporations have racked up approximately $100 billion in foreign currency debt, JPMorgan estimates.

On Wednesday, $117 million in interest payments on dollar-denominated government debt are due.

But Russia is increasingly isolated from global financial markets, and investors are losing hope that they will see their money. As the government strives to protect what’s left of its access to foreign currency, it has suggested it would pay its dollar- or euro-denominated debt obligations in rubles instead. That has prompted credit rating agencies to warn of an imminent default.

The Russian currency has lost nearly 40 percent of its value against the U.S. dollar in the past month. Even if the payments were made, economic sanctions would make it difficult for Western lenders to access the rubles if they are in Russian bank accounts.

“It is not that Russia doesn’t have money,” Kristalina Georgieva, managing director of the International Monetary Fund, told reporters last week. The problem is, Russia can’t use a lot of its international currency reserves, she said, because they have been frozen by sanctions. “I’m not going to speculate what may or may not happen, but just to say that no more we talk about Russian default as an improbable event.”

Last week, the chief economist of the World Bank said Russia and Belarus were squarely in “default territory,” and Fitch Ratings said a default was imminent because sanctions had diminished Russia’s willingness to repay its foreign debts.

Russia last defaulted on its debt in 1998, when a currency crisis led it to default on ruble-denominated debt and temporarily ban foreign debt payments. The crisis shocked the financial world, leading to the collapse of the U.S. hedge fund Long-Term Capital Management, which required Federal Reserve intervention and a multibillion-dollar bailout. If Russia failed to make payments on its foreign currency debt, it would be its first such default since the 1917 Russian Revolution.

Foreign investor interest in Russian assets fell in 2014 when sanctions were imposed after the country annexed Crimea, and never fully recovered before more sanctions were imposed by Washington in 2019. But holdings aren’t negligible. Russian government bonds were considered investment grade as recently as a few weeks ago, and were included in indexes used to benchmark other funds. JPMorgan estimates that international investors own 22 percent of Russian companies’ foreign currency debt.

Funds managed by BlackRock, the world’s largest asset manager, have incurred $17 billion in losses on Russian assets, including equities, in recent weeks, according to the firm. The loss in value has a number of causes, including investors selling their holdings.

But so far, regulators have said the risk to global banking systems from a Russian default wouldn’t be systemic because of the limited direct exposure to Russian assets. The larger ramifications from the war in Ukraine and Russia’s economic isolation are from higher energy and food prices.

Still, financial companies have been scrambling to assess their exposure, according to Daniel Tannebaum, a partner at Oliver Wyman who advises banks on sanctions.

“I’m seeing a lot of clients that had exposure to the Russian market wondering what type of default scenarios might be coming up,” said Mr. Tannebaum, who is also a former Treasury Department official. In the case of a default, “those bonds become worthless, for lack of a better term,” he said.

On Monday, Russia’s finance minister, Anton Siluanov, accused the countries that have frozen the country’s internationally held currency reserves of trying to create an “artificial default.” The government has the money to meet its debt obligations, he said, but sanctions were hampering its ability to pay. Mr. Siluanov had also said over the weekend that the country had lost access to about $300 billion of its $640 billion currency reserves.

The government insists investors will be paid. The finance ministry said on Monday it would send instructions to banks to issue the payment due on dollar- or euro-denominated bonds in dollars or euros, but if the banks don’t execute the order then it will be recalled and payment will be made in rubles instead. The statement also said that the payments could be made in rubles and then converted to another currency only when the country’s gold and foreign exchange reserves are unfrozen.

“In any case, obligations to our investors will be met. And the ability to receive the funds in foreign currency will depend on the imposed restrictions,” Mr. Siluanov said.

But the statement doesn’t provide a clear vision of what might happen on Wednesday. American sanctions allow for the receipt of payments of debt obligations until late May, and so the reasoning behind the Russian finance ministry’s claim that banks might refuse the payments is unclear. The payments due on Wednesday also have a 30-day grace period, so a default wouldn’t technically happen until mid-April. But Russia has already blocked interest payments on ruble-denominated bonds to nonresidents, a sign of its hesitancy to transfer funds abroad.

While the Russian finance ministry said it could meet its obligations by paying in rubles, others disagreed.

“In order to avoid a default, the only way that Russia can really navigate this is to send the full payment in dollars,” said Trang Nguyen, an emerging markets strategist at JPMorgan.

Some Russian bonds issued in recent years do have provisions that allow for repayment in other currencies, including the ruble, if Russia can’t make payments in dollars for reasons “beyond its control.”

For investors, payment in rubles would be little more than a positive talking point for Russia, according to Jay Newman, who helped lead the 15-year legal battle against Argentina over defaulted debt at the hedge fund Elliott Management.

“It just gives them a little more opportunity to claim that ‘we did what we could, but we are prevented by our enemies from actually keeping our clients’ bonds,’” Mr. Newman said.

Investors have already taken the financial hit, he added. Russian bonds are trading at an average of about 20 cents on the dollar as traders have priced in a default. There has also been forced selling of bonds after the assets were kicked out of indexes, pushing the prices down further.

Some of the institutional investors with larger holdings include BlackRock, Pimco, Capital Group and Vanguard, according to data compiled from Bloomberg. Vanguard, a large provider of mutual and exchange-traded funds, recently said it had suspended purchases of Russian securities in its actively managed funds and was working on exiting the positions in its index funds. Pimco, the large asset manager that specializes in bonds, and had built up a sizable exposure to Russian debt, declined to comment on its holdings. Carmignac, a French asset manager, said last week that it was divesting from its Russian holdings.

Officials have been trying to assess the impact the war and the sanctions leveled at Russia could have on the global financial system. In late February, members of the Financial Stability Oversight Council, part of the Treasury Department, received a briefing on international market developments related to Ukraine and noted that the U.S. financial system continued to function in an orderly manner.

Andrea Enria, the chair of the European Central Bank’s supervisory board, said on Tuesday that the direct exposure of banks in the eurozone to Russian assets appeared contained and manageable. For example, Russian and Ukrainian debt securities made up about half a percent of eurozone investment fund debt holdings.

“So far we have seen nothing particularly disruptive,” even in indirect exposure to Russia, he added. Still, there are risks stemming from a Russian debt default and broader financial market volatility, especially in markets linked to oil, gas and other commodities, he said.

“In the aggregate, Russia is not systemically risky, however there are people that hold big chunks of Russian debt and they have to figure out what to do,” said Paul Cadario, a former World Bank official who in the 1990s oversaw the bank’s budget for Central and Eastern Europe and the former Soviet Union.

“There’s going to be some player that nobody has noticed that all of a sudden is in distress, then you have to hope that it’s not systemically significant or dangerous to the broader financial sector,” said Mr. Cadario, who is a fellow at the University of Toronto’s Munk School of Global Affairs and Public Policy.

And it is unclear what will happen to investors who have bought credit default swaps on Russian sovereign debt — a kind of insurance that it designed to pay out in the event of a default — if Russia attempts to repay foreign bondholders in rubles.

If Russia does default on its sovereign debt or repay in rubles, bondholders could struggle to get repayment through the courts because for debt issued in dollars and euros in recent years, Russia didn’t waive its sovereign immunity, limiting the ability of bondholders to sue in the event of a default.

“It’s not to say that creditors won’t be able to take Russia to court and get a judgment — but it’s going to be a long, hard slog, and nobody knows what the rules are,” Mr. Newman said.